The recent pullback in the prices of many commodities has led a great many pundits to declare that the boom has run its course. I could not disagree more. While it is true that general commodity prices have retreated somewhat from a heavily over bought position achieved in the first quarter, the fundamental supply and demand laws have not been repealed. This run up in commodity prices is not over. Recent evidence would, in fact, suggest otherwise. Let us first examine the agricultural sector.

Skyrocketing food prices have made headlines all around the world. Amid the ethanol craze, silo stored corn supplies in the U.S. are at 14 year lows. In an attempt to bolster Gross Domestic Product, or GDP, the administration has decided that the energy that’s generated from domestically grown corn is more advantageous to the U.S. economy than oil imported from the Middle East. This demand will drive corn products up. India, reeling from acute rice shortages and rising prices, has taken steps to eliminate food speculation by restricting purchases by all but actual end users. This demand will not abate, but will merely move to exchanges which do allow such speculation. In the midst of all of this, global food prices have risen as much as 60 percent since last year.

Recently a United Nations official warned of civil unrest. “If prices continue to rise, I would not be surprised if we began to see food riots,” said Jacques Diouf, Director-General of the U.N.’s Food and Agriculture Organization. Against this backdrop, rising grain prices have begun to impact the finished cost of food goods. Governments have begun to limit food exports and hoarding has increased. Oil and food are the most critical components of the world’s economy. Yet whenever the core inflation index here in the U.S. is cited, it is usually accompanied by the phrase “excluding food and energy”. Food, without a doubt, is more critical than energy. However, creating food depends on the use of energy. Oil is the primary source of that energy. Having oil prices over $120 a barrel generates severe global impact. This surge in oil prices is most notably affecting the new manufacturing countries like China and Korea. While we allowed the exportation of the greater portion of U.S. jobs and heavy manufacturing offshore, these countries have built their entire economies on heavily energy dependant smokestack industries. For the most part, they also have no domestic oil production. This extensive reliance on energy to fuel the Asian manufacturing orgy means a greater sensitivity to rising prices.

China, for example, has imposed strict controls on the price of fuel. This has led to disruptions in the supply, and black market operations throughout the Country. (psst, hey buddy... wanna buy some gas?) The United States has undergone a period of conversion from a manufacturing giant to a king of the service economies. In retrospect, this shift has demonstrated its upside in that we don’t have the drain of higher energy prices impacting industrial growth. What we have built to replace our manufacturing base is a financial service industry, and growth in that arena is relentless. The over-the-counter (OTC) markets of all categories of derivative contracts rose to $596 trillion at the end of December, up from $450 trillion in January. The expansion in the foreign exchange and commodities segments recorded double digit growth rates. Additionally, recent injections of liquidity by the Federal Reserve Bank of New York (see chart) have all but guaranteed the continued increase in the cost of living. Steadily increasing injections of money have had the desired effect, although they have staved off the collapse many predicted.

The cure is worse than the disease. All of this extra money will dilute the value of individual savings. Meanwhile the demand for money at the federal level continues unabated. The Bush Administration says that it is re-issuing the 1-year Treasury Bill for the first time in 7 years. The government's borrowing needs for the current quarter include $15 billion of 10-year Treasury Notes and $6 billion in the sale of 30-year Treasury Bonds. The Department of the Treasury allows investors to purchase Treasury Securities in amounts as low as $100. The previous minimum was $1000. This reveals the level of desperation in meeting cash needs. “Over the last several months, changes in economic conditions, financial markets and monetary and fiscal policy have impacted Treasury's marketable borrowing needs,” said the Treasury’s assistant secretary Anthony Ryan. “Financial market strains have impacted the real economy and the nation has experienced lower economic growth, lower receipts and increased outlays.” This, in a nutshell, represents the ultimate growth engine in the money supply. With deficit projections in the $400 billion range for the next 5 years, the Federal Reserve will have no choice but to fund these shortfalls with newly created dollars. This influx of money will assure further devaluation of the dollar which will fuel the commodities boom.