Markets in Crisis: Inside the Commodities Bubble

For those following economic trends, the past 18 months are notable primarily for two reasons. First, the U.S. housing market, long seen as overvalued by alternative economists and even powerful economic institutions including the International Monetary Fund (IMF), finally went from boom to bust. Over the span of a few months, housing in some markets depreciated by as much as 30 percent, and some economists estimate that losses may ultimately reduce value by as much as 50 percent in some cities.

Second, the market for commodities, especially food and oil, has been growing at an alarming rate. While the per-barrel price of crude oil has been rising since about 2005, the upsurge in food prices has been even more rapid. Rice, the world's largest staple crop, has more than doubled in value since January of this year alone, with wheat prices not far behind. Economists are citing many reasons for the upsurge in grain prices, including increased demand in developing countries, especially India and China, as well as poor harvest due to adverse weather conditions in some places.

While changing consumption and production patterns due to things like global warming and the wasteful consumption patterns (particularly in the developed world) may be a worry, in most of the world grain stores are still more than sufficient to handle these fluctuations. With the exception of East Africa, where there are genuine shortages and a genuine danger of famine, the rise in global food prices can't be explained solely in terms of supply and demand.

Economists also agree that speculation is playing a role in pushing up global food prices. They argue that many investors are engaging in hoarding or other kinds of speculation, anticipating that they will receive bigger returns on their investments in the future than what they could make now.

According to this mainstream argument, speculation is a secondary or less important reason for the price boom, with supply and demand factors and rising fuel costs being the primary factors.

While the story of rising food costs is no doubt a complicated one, the sudden rise of commodities prices and the simultaneous collapse in many financial markets is unlikely to be a coincidence.

Markets in Crisis

While many economists maintain that speculation can be a way to increase demand to keep markets flexible, the global economy depends on speculation to a dangerous extent. In the past two decades, we have seen two examples of that dependence on speculation crashing around us, first with the "dot com bubble" of the 1990s and more recently with the housing bubble.

In each of these cases, speculation bred more speculation as investors sought to cash in on seemingly endless growth -- until the bubble burst and they dumped their holdings. In the case of the housing bubble, deregulation meant that mortgages could be broken up, sold and resold to small and large companies, making it difficult for investors to track sound loans from unsound loans.

In this case, some of the worst disasters could have been averted or at least detected earlier if analysts had been interested in asking the right questions. Those who did ask those questions, including many progressive economists, were ignored. As Chuck Prince, head of Citigroup at the time, famously stated, "When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance."

That's a deeply troubling attitude. The willingness of investors and companies to go along with speculative bubbles and the prevalence of a huge amount of speculative capital in the global economy generally may have grave implications. These conditions suggest that the bubbles may not be the disease in themselves, but the symptoms of something much deeper. The market may be so based on speculation, and speculative investors have such a tendency to "herd" together, that we are in a chronic bubble economy. The economic bubble of the day may change -- "emerging markets" bonds one day, tech stocks the next, and home mortgages the day after that -- but the presence of a bubble may be ubiquitous.