The prices of commodities including oil
have surged this year as much of the global economy shakes off COVID restrictions and as Russia’s invasion of Ukraine has led to a key commodity-exporting region to be cut off from the the rest of the world.
This volatility has not only helped fuel levels of inflation not seen in 40 years —market observers are warning that it could put the stability of the global economy at risk unless regulators and central banks wake up to the threats posed.
“One after another development related to Ukraine is exposing the long standing flaws in the increasingly obsolete post-Second World War framework” of global trade and financial regulation, Karen Petrou, managing partner of the financial-policy think tank Federal Financial Analytics, told MarketWatch.
Petrou argued that rapidly increasing commodity prices are putting stresses on both commodity traders and the banks and other actors that fund them, and failures to properly regulate these entities could force the Federal Reserve to bail them out, a move that threatens popular backlash.
In the aftermath of the financial crisis, regulators debated whether to designate large commodity dealers like Glencore, Trafigura, and Archers-Daniels-Midland Co.
as Systemically Important Financial Institutions, which would subject them to greater regulatory scrutiny, “but they didn’t have the guts to go there” Petrou said.
Recent volatility also underscores the relationship between inflation and financial stability, according to Zoltan Pozsar, global head of short-term interest rate strategy at Credit Suisse.
“Central banks are in love with this idea that they control price stability,” he said in a telephone interview. “I find it shocking that entities as crucial to price stability as [commodities traders]” are not more closely overseen by the Fed.
Pozsar argued that the war in Ukraine will be a turning point in financial history that will catalyze a partial reversal of globalization and usher in a new monetary order based on the prices of commodities rather than the U.S. dollar. In such a world, the Fed and its counterparts abroad will be unable to ignore the central role played by commodity traders.
“These are the entities that move the basic commodities around that you need for industrial activity and price stability,” he said. “A commodity trader guarantees price stability, not central banks.”
Regulators are taking notice of these dynamics, even if they are not yet acting on it. The International Monetary Fund cautioned on Tuesday of “severe pressures in commodity financing and derivatives markets” in its semi-annual report on global financial stability, following the news earlier this month that the U.S. Financial Stability Council was briefed by the Commodity Futures Trading Commission and the Federal Reserve on the impact of commodity markets on financial stability.
Ramit Singh, assistant director of the IMF’s Monetary and Capital Markets said in a press conference Tuesday that it’s “probably an opportune time” for regulators to study the commodity space to identify gaps in regulation of commodities markets.
Dennis Kelleher, president and CEO of the non-partisan financial-reform organization Better Markets, told MarketWatch there are steps the CFTC could take to stabilize commodities markets, like enforcing stricter position limits on commodity derivatives trades, that would both reduce prices for commodities and reduce the risk of financial contagion.
A position limit is a control on the number of contracts any one entity can own at a given time, in order to prevent excessive speculation and volatility in commodities markets. The CFTC passed new rules on position limits in 2020, as required by the 2010 Dodd Frank financial reform law, but critics, including current CFTC Chairman Rostim Benham, have said these rules don’t go far enough.
“Commodity speculation is largely unregulated because there are no position limits, or the limits are so high that they’re meaningless,” Kelleher said. “These issues are interconnected. On the inflation front, instead of enacting position limits that work, which would bring prices more in line with supply and demand, we have large banks advising clients to shift more of their portfolios into commodities as a so-called inflation hedge.”
The CFTC declined to comment for this story.
Whether or not regulators decide to change policy in the face of rising volatility, Credit Suisse’s Pozsar argued that Americans should prepare themselves for a world in which the markets for key commodities become a space for geopolitical competition.
That likely means that commodity prices will remain a major driver of inflation going forward and that if the global economy faces another systemic crisis, commodities will be at the center of it.
“That’s the definition of systemically important,” Pozsar said of commodities dealers. “Much like Lehman moved bonds and cash around until it didn’t, these companies move commodities around until they don’t.”