Yields on benchmark 10-year US and UK government bonds fell to record lows of 1.97 per cent and 2.24 per cent respectively last week, while German bund yields tumbled to 2.09 per cent..

These moves were partly a reflection of surging demand for perceived “safe haven” assets amid wild swings in financial markets, as well as expectations that interest rates will stay lower for longer. But these miserly yields must also reflect investors’ confidence that inflation will be muted over the next decade. How logical is this assumption?

Given the credit crisis and the sharp drop in economic output the developed world has gone through, it is understandable that central banks should talk about output gaps and economies working at markedly below their potential capacity.

The implication is that domestically generated inflation will remain at low levels until this excess capacity is eventually soaked up by rising output. This may well prove so, even if this analysis does skirt over the fact some of the capacity available at the peak of the cycle only existed because of excess, cheap leverage, and may well have disappeared forever.

More importantly, this insouciance about the prospects for inflation misses the international dimension, that stemming from rising import prices.

Investors are not alone in feeling relaxed about this factor, central bankers are too. In last week’s letter to the UK government explaining why consumer price inflation remains at 4.4 per cent, Mervyn King, governor of the Bank of England, referred to inflation being fuelled by “temporary factors”, such as “past increases in global energy prices and import prices”.

Most will hope he is proved right, and that elevated energy and import prices, faced not just by the UK but by the wider developed world, will now subside, allowing inflation to recede to levels more in keeping with sluggish domestic demand.

But can investors and policymakers afford to sit back and relax in the certainty that this course of events will unfold?

Unsurprisingly, recessions in the developed world, and the concomitant reduction in global demand, have tended to coincide with weakness in commodity prices, encompassing the vital inputs of energy, metals and food. During all but one of the nine recessions in the US since 1957 global commodity prices, as measured by the CRB Index, have fallen, with the 2007-09 episode no exception.

As well as providing a tailwind for economic recovery, these falling commodity prices have helped push generalised inflation lower, both during recessions and their immediate aftermath, as economies build back up to full capacity.

For the seven US recessions between 1957 and 1991, commodity prices on average fell 1.6 per cent during the period between the start of the recession and two years after its end.

The equivalent figure for the two recessions so far this century is a rise of 27.3 per cent.

While this could just be a statistical fluke, an alternative explanation is that something has changed. It’s not hard to work out what that something might be. Emerging markets last year accounted for more than half of global gross domestic product, measured on a purchasing power parity basis, and 38 per cent of GDP based on market exchange rates, twice their share in 1990. And these emerging markets have largely carried on serenely throughout the western downturn, meaning global demand has remained robust and commodity prices have stayed at elevated levels.

One hopes investors currently buying US, UK and German debt at such pitiful yields fully appreciate that this situation is not a one-off, but the new normal. Unless pretty much every economist, analyst and commentator is wrong, emerging markets will continue to account for an ever larger share of global output for the foreseeable future.

Rather than enjoying a tailwind from falling commodity prices and low inflation rates, it may become the norm for recession-ravaged developed nations to face a commodity headwind and stubbornly high inflation.

The likelihood of this scenario is enhanced by an ever-rising global population, which has surged from 1.65bn in 1900 to a smidgen under 7bn today.

The population is currently growing at 83m a year, or nearly three people a second, and is likely to continue rising rapidly, particularly in a world where seemingly not a single politician possesses the insight and courage to draw a connection between rising populations and global warming, spiralling food demand, habitat destruction and biodiversity loss.

It is true commodity prices broadly fell in the twentieth century, even as global population rose sharply. But again, things may have changed. Throughout human history, the bulk of the world’s population have been light users of commodities. That has changed, almost certainly permanently. The perceptions of investors and policymakers alike may need to undergo a similarly radical shift.


steve.johnson@ft.com

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