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Housing was a bubble, commodities are not

April 26, 2011

When I read otherwise intelligent people calling precious metal price increases “a bubble”, I have to conclude that they don’t understand the difference between a bubble and simple repricing.

Here is a simple explanation: Housing was a bubble. Why? Simple. The Federal Reserve monetary and credit injections into the economy, by policy, are fed into the banks. That’s how it works. The banks get the credit. Banks are in the business of lending. That is their business model. It’s what they do. Mortgages are a form of borrowing. Banks were recipients of an immense amount of money and credit and they lent it out. There was a stampede to borrow at low interest rates and irrelevant credit riskiness. The rise in prices of houses was not the result of a reevaluation of housing based on the supply of money. It was, instead, the distortion of demand for houses (and commercial real estate, etc.) based on brand new, easily accessed credit flowing through the banks.

Commodities are a different story entirely. If commodities do anything at all, they reflect the scarcity (or lack there of) of money. All the new money rolling around in the system has required a repricing of food, energy, raw materials, and precious metals. This isn’t a case of credit injection into banks and banks buying up precious metals (that would be bubblesque). In fact many banks have been aggressively shorting metals. This is, rather, a case of commodities reflecting the massive increase in money supply.

In economic terms, we’re talking about the difference between shifts in demand curves vs movement along a demand curve. Sound economic theory is something you’ve either been exposed to or you haven’t. People talking about a bubble in commodities fall in the second group.

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