Commodities cause less worry, knock on wood


It used to be that our economic fortunes were tied ever so closely to commodity prices. If prices rose too much, the economy slowed and the stock market slumped. And if they fell far enough, the economy accelerated and stock prices soared.

That relationship between the prices of raw materials and the prices of stocks was even close enough to spawn a Wall Street aphorism: "Every bull market has a copper ceiling."

On its face, that saying seems to make a lot of sense. Commodities -- raw materials such as oil or copper, or agricultural products like soybeans or wheat -- go into a lot of the products we buy. Plus, oil is used to make fuel or gasoline, which is needed to ship products to market via air or by truck. So if those "ingredient" prices rise, so should the prices of the finished goods.

Higher prices equate to lower demand -- slowing the economy, crimping corporate profits and causing stock prices to slide. And higher prices also equate to "inflation," which will bring the current inflation-hating Federal Reserve regime into action, causing it to raise short-term interest rates, which should slow the economy that much more.

As consumers enjoying the current boom, we can clearly see that the prices of most commodities have not been a problem. Indeed, the market prices of many raw materials -- except for oil -- are near their lowest point in decades. The gross domestic product price deflator, one measure of how much inflation there is within an economic system, rose only 1.9 percent in the fourth quarter, which is hardly bothersome.

Most economists say low raw materials prices are yet one more reason that the "Goldilocks Economy" has set records for duration without sparking ruinous inflation.

One recent study may have discovered something important about a new role commodity prices play in this so-called Goldilocks Economy: Thanks to changes in the U.S. economy -- particularly the shift into service and technology businesses -- even a run-up in raw-materials prices doesn't mean that copper ceiling will cave in anytime soon.

In the study, Merrill Lynch & Co. Senior Economist Gerald D. Cohen found that commodity prices, including oil, have since the early part of the 1980s had little to do with the "core" component of the Consumer Price Index -- that is, the part of that inflation measure that excludes volatile food and energy prices.

"We are much less dependent on commodities than ever before," says Cohen, who is also a former economist at the Federal Reserve.

That wasn't true in the 1970s and before, when the United States was heavily focused on such basic smokestack industries as oil, steel and manufacturing. When you make steel, your fortunes are heavily dependant on the prices for such raw materials as iron ore; when you make cars, you're very concerned with the going price for steel.

But, Cohen says, we've become a knowledge-based economy -- one based on ideas, innovation and know-how -- and that has diminished our dependence on commodities, and perhaps tied this country less to the business cycle, some economists believe.

This economic makeover has even changed how we use energy. Electricity as a percentage of our total energy consumption has risen from 25 percent in the 1970s to 33 percent today. That means we've diversified our economy's dependence away from other energy sources. What's more, other studies show, we've become more efficient, doubling our economic output per barrel of oil consumed. That's healthy.

According to Cohen's study, the U.S. economy can bear up quite well, so long as commodity prices rise at a reasonable rate and to reasonable levels. What's reasonable? Well, according to Cohen, neither the current level of oil prices, nor the level they are projected to reach in the summer, are any causes for alarm.

Naturally, not everyone, including Robert T. Sweet, chief economist for Allied Investment Advisors in Baltimore, agrees with this assessment. Though commodity prices remain low, the current trajectory for many raw materials has been upward -- a trajectory that may continue since the U.S. economy continues to surge even as economies abroad continue their recovery from the unpleasantness brought on by the "Asian contagion" of 1997 and 1998.

Crude oil, for instance, was quoted last week after OPEC said it would increase production, at $26.60 a barrel, down 23 percent from the nine-year high of $34.40 reached in early March but much higher than a year ago. And most economists expect pump gasoline to remain pricey through the popular summer driving months since demand at that time is so heavy.

"The price of oil at $30 a barrel is finally working its way through to the pumps," says Sweet.

Sweet thinks that higher prices for raw-materials ingredients, as well as for oil, which influences both the production and delivery prices of products, eventually must be passed along to customers -- pushing up the prices of products ranging from Starbucks coffee to gasoline. That will put a ceiling on growth, even if it's not a copper one.

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