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Why a slide in commodity prices is a good thing

The price of oil is down 17 per cent from its May peak. That drop might reflect the fear of renewed recession, but the fall can stop that danger from being realized. Price cuts can be good for you and policy makers should avoid reversing them.

The commodities' slide ends a period in which economists and commodity buyers seemed to be living in different worlds. The economic story was of a frail world that could be about to fail. Yet oil and most other commodities rose into the stratosphere. They are still far from falling to earth, Brent is still 32 per cent higher than last year.

The apparent disconnect can be resolved. Growth has been weaker than hoped in developed economies but still strong enough in emerging economies to help keep prices high. But investment and monetary factors are also at play. Investors have turned to commodities to profit from emerging market growth. And the latest commodity bull run began in November, 2010 – when the U.S. Federal Reserve launched its $600-billion second round of quantitative easing. That program ended in June and the global market retreat started a few weeks later.

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Whatever its cause, the inflationary impact of higher commodities is strong worldwide. U.S. gasoline prices are up by 32 per cent in the past year, with U.K. fuel prices rising by 17 per cent. Higher pump prices help explain why Western consumers are parked. In emerging economies, commodity prices have helped push inflation to 6.2 per cent in China, 7.2 per cent in Brazil and 8.4 per cent in India. Interest rates in emerging economies have been rising. The tightening is beginning to tell on EM growth – and the world's.

Lower commodity prices will reverse these bad trends, putting money in the pockets of Western consumers and calming central bankers in emerging economies.

The lesson may be that in a globalized world economy of swift capital flows money printing as a form of extreme stimulus risks being counter-productive, because the printed money flows to economies that are already growing fast. It may therefore take an end to stimulus to produce non-inflationary growth. The Federal Reserve should therefore not rush to calm market nerves with more money printing.

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