Hamish McRae: Hot commodities are the markets' way of telling us to slow down or get burnt

Will it turn out to be soaring commodity prices that curtail the current global boom?

The two astounding features of the world economy over the past year have been its resilience to rising interest rates and its resilience to rising commodity prices. The apparent ineffectiveness of rates has led to a debate about the legacy of the surge in global money supply over the past five years, and to questions about the impact of strong savings in Asia.

Could it be that so much money is swishing around the world that even higher rates will be needed to curb the rise in asset prices? Looking at Britain, it seems evident that the present cost of borrowing may not be enough to cap house prices. These seemed to have come off the boil last year, but now, after only the smallest of rate cuts, they appear to be on the move up again. Much the same arguments apply to the US housing market; it too seems to have shrugged off a rate rise.

Or is the explanation more about global savings and global capital flows? If Japan and China save enough, and invest enough in the US to cover the American current account deficit, that will hold down long-term rates in the US and so render its bond market less vulnerable to rising short-term rates.

The answer is that we don't yet fully understand what is happening; we just know it is odd.

But even more odd is the reaction to rising commodity prices. The most important single commodity, oil, is the closest it has been to its all-time high in real terms. The present price, close to $65 a barrel, compares with $85 a barrel, in today's money, in the early 1980s - a price that led to a global recession.

It is not just oil. Basic metals, such as copper and zinc, have shot up too. In theory, apparently, it is worth melting down US cents because the metal in them is worth more than the face value of the money. Coal and gas have also risen in line with oil, and gold and silver have made a comeback.

The biggest single reason for the commodity boom is almost certainly the strong demand from China. If you take oil, the US is the world's largest consumer and China the second largest. Roughly half the world's oil is used by two countries.

If you look at energy as a whole, China is the fastest-growing user. Every year it builds new power stations with the equivalent output of the entire UK generating capacity. Some 80 per cent of that output is coal-fired. The first graph shows how the country's imports of raw materials have shot up over the past four years.

This leads to two linked questions. Why are surging commodity prices not feeding through into inflation more generally? And if Chinese (and Indian and US) growth continues at the present pace, will this eventually put so much pressure on commodities that the growth is snuffed out?

The simple answer to the first one is that rising raw material prices have been offset by falling labour costs. Looked at globally, the more that Chinese-produced products enter the world market, the greater the impact of low Chinese wages. So the price of finished goods is held down despite the higher cost of the materials needed to make them. This may not be the full answer but I think it is most of it.

You can see this phenomenon in Britain, where the price of goods in the shops is falling by around 1 per cent a year. But many of these are made either in China or in other low-wage Asian countries. By contrast, our heating bills have gone up and the price of fuel at the pumps is within a whisker of passing £1 a litre. (The price of public sector services, rates and taxes, is also rising, but then we cannot buy our public services from China.)

What happens next is more difficult to judge. Historically, since the Industrial Revolution more than 200 years ago, the tendency has been for the long-term real price of commodities to fall. In real terms, commodities excluding oil are now about one-third of the price they were in 1800. It has proved cheaper to mine the stuff and we have learnt how to use raw materials more efficiently. For example, substituting fibre-optic cables for copper ones to carry telecommunications data means that much less copper is needed.

Oil is different because its supply is more limited and we have come to rely excessively on it. But oil apart, in the long term it is hard to envisage a generalised commodity crisis. The short term may be different. Thanks to generally low mineral prices, investment in bringing on new production was not strong in the 1990s. Now it is. Eventually, supply will be increased and heavy users of raw materials will figure out how to economise on their use.

This will take time. So we could easily face a five-year squeeze, with generally high commodity prices, and that will tend to curb growth. Put simply, money spent on petrol for driving to the supermarket is money you can't spend when you get there.

So when that squeeze occurs, will it end the growth phase? My instinct is that it will be part of the explanation but not the whole one. The rising cost of imported materials and oil does account for part of the US trade deficit, but take oil out and that gap is still widening, as the middle graph shows. Take oil out of the UK trade accounts and we show much the same pattern (third graph), though we are in better shape. (The US current account balance is equivalent to more than 6 per cent of GDP, whereas the UK's is about 2.5 per cent.)

The key point here is, yes, inflation remains under control in the US and UK despite the rising cost of commodities, but this is largely thanks to our importing more cheap goods. These hold down overall price levels, compensating for more expensive commodity imports. Our success on the inflation front is a directly linked to our rising trade deficits.

If this line of argument is right, then commodity prices will be part of the mix of factors that ends the boom. Other factors will include the inability of the US to go on increasing its trade deficit - partly because it won't want to and partly because it won't be able to finance the deficit. It will also have something to do with the end of the US housing boom, which has to happen sooner or later .

Final point. None of this means a global slump is inevitable. What it does mean is that rising commodity prices, like rising interest rates, are symptoms of strain in the world economy. And these strains are likely to be more marked if growth continues more swiftly than can be sustained in the long term.

The commodity markets are flashing amber. They are saying "slow down or there will be a big problem".

Why the Easter gridlock is good for us

Easter, and there is a high chance you will be reading this in transit. This is the single busiest time for the airports and the roads - as people who struggled to travel somewhere on Maundy Thursday and Good Friday are all too aware.

This raises an intriguing economic issue: why is Easter such a travellers' nightmare and, more generally, why do we take our holidays at the same time?

While school holidays force families to take their time off in quite narrow windows, that does not fully explain why travel is so compressed. Why, for example, don't more people set off in midweek? When most of the workforce was in factories, it made sense to shut down the plant for a fortnight, so everyone went off on their break at the same time. But work patterns are quite different now, or so you might imagine.

Try pondering two explanations. One is the legacy effect. Once people get into the habit of an Easter holiday, they tend to stick with it. The other is that while most service industry jobs (which is where most people are employed now) need to be done continuously, it is more efficient to have employees off work at the same time.

If you look at the output of a service industry, that has to be provided all the time. You can't just shut down a hospital and start again two weeks later. On the other hand, if you look at the way a supermarket or hospital is run, it needs key people at all levels to be able to communicate with each other. If some are taking random time off, that slows down the communication process. Much better if everyone knows it is hard to get decisions in the 10 days round Easter. The same applies to August and the Christmas-New Year periods.

I hope that knowledge - that it is more efficient for the economy as a whole for us to take holidays at the same time - eases the pain of the fight through the airport or the hours on the motorway. If not, the answer is to have a holiday in the low season... and bring a laptop.

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