The Business Cycle Exists Because Central Banks Make It So

US dollar devaluationThe strength in commodity prices is good for producers and investors, and not so good for consumers, whether they be industrial manufacturers or shoppers at the grocery store. So, while the commodity price cycle is profitable for some, it actually could serve to hurt manufacturing and consumers who rely on price stability.

Partly, it’s a circle of unintended consequences on the part of the Federal Reserve. The very economy central bankers want to stimulate might be weighed down for years by the price inflation the central bank creates through its policies. After all that’s transpired over the last few years with mortgage meltdowns and financial crises, I’m beginning to think that the economy would actually be better off managing itself. Direct intervention on the part of central bankers is looking less useful than reasonable regulation of a marketplace.

Currency intervention by governments and central bankers always wreaks havoc in other capital market and a lot of commodities are going up in price now mostly due to the devaluation of the U.S. dollar. While the intention of trying to re-inflate the U.S. economy is sound, it’s likely this time that a sustained period of global inflation will transpire.

So, if you believe in this fundamental backdrop, how do you make any money? Or, perhaps a more pertinent question is: how do you ensure you don’t lose money on your holdings?

First off, you must have some exposure to a basket of commodities either through equity ownership or some kind of exchange traded fund (ETF). In fact, the time for taking on this kind of position has already passed. Second, you need to avoid leverage through debt. With higher inflation come higher costs and higher interest rates to service debt. Rates aren’t rising yet, but they will eventually. And third, you need to own real assets like land and housing. Real estate benefits in an inflationary environment, and the good news is that now is a great time to be a buyer.

The business cycle will always exist in a free market. Government’s desire to intervene in a free market will always exist. But, instead of flooding or withdrawing a marketplace with cash, I think an open economy is better served by having reasonable rules that don’t let things get out of control in the first place (like a bank lending hundreds of thousands of dollars to a homebuyer with no equity, little income, and a rising interest payment schedule.)