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The “Fed didn’t do it crowd” has been floating this chart around the web.

Click to enlarge

click to enlarge

It purports to prove that commodities inflation is due to industrial demand and not to Fed money printing. But they left something out. “What’s that?” you ask. Why, they left out Fed money printing, of course.

I don’t have the data for world industrial production. I will assume that the above chart is truthful and that the correlation it shows is accurate. In fact, I am sure that it is accurate. The only problem is that it attributes cause and effect while ignoring the root cause.

I do have a chart (made it my very own self) that shows US industrial production, AND the PPI for raw commodities and slightly processed goods, AND, most importantly, the overall level of Fed money printing, aka, the System Open Market Account which is the sum total of all POMO. Since the Fed itself says that it is not responsible for what happens in the rest of the world, let’s concentrate on the data for which it is responsible, US producer prices, and US industrial production and just accept that the rest of the world’s production has been very strong.

Fed SOMA, Industrial Production, and Commodities Inflation- Click to enlarge

Each line is indexed to the average level of 2008. Fed SOMA (POMO or money printing) is on the left scale and Industrial Production and commodity prices as measured by the PPI are on the right. So let’s be clear here about what came first. Clearly, it was the money printing. THEN the commodity prices reversed, and ONLY AFTER that did industrial production begin to increase. The Fed is clearly the fountainhead here. If you think this is a fluke, the data back to 2003 shows an equally strong direct correlation.

The second thing to notice is that the response of prices to the Fed’s additions to SOMA is stronger than is the response of US industrial production. Prices are up approximately 22% since the trough in early 2009. Production is only up about 12% and it has stalled over the past 6 months, showing the diminishing marginal utility of the Fed’s pumping.

But the opposite is true of commodity prices because of the method in which POMO works. POMO goes first through the conduit of Primary Dealer trading accounts. And guess what else it is that they trade. Did you guess commodity futures? Congratulations. It only takes a few billion dollars spread around among the various complexes over time to keep the fires burning under these trends. This is pocket change to the dealer crowd, whose banking arms are also extending the credit to the leveraged speculating community to play this game.

So it is that commodity prices move first and farthest, as the production behemoth lags farther and farther behind. The dead stop in production over the past 6 months as prices accelerate is an ominous sign that inflation is overwhelming the production apparatus.

Note that when the Fed stopped its pumping operations in the first half of 2010, commodity prices again responded instantly, and stopped rising throughout the period during which the Fed was on hold. Industrial production continued rising for the first half of that period, then it too stalled and has remained stalled. But as soon as the Fed resumed heavy POMO buying in August, commodities began to move again.

It’s important to recall that the Fed actually started buying Treasuries from the Primary Dealers back in August to replace the MBS securities that were being paid down from its balance sheet. These initial cash infusions were the trigger for the resumption of the rise in commodity prices. Total Fed SOMA did not begin to increase until November when the Fed started QE2. That’s when the commodity price rises exploded. But the Fed began pumping cash into dealer accounts back in August. That’s when the commodities began to move.

Meanwhile, industrial production is dead in the water. It therefore appears that not only is the Fed directly responsible for this disastrous inflation, but its policy of printing money is suffering immensely from the law of diminishing marginal returns. POMO is no longer having the desired affect. It worked for a while, but the impacts of the inflation, the negative side of the coin which the Fed and its apologists want to pretend don’t exist, are pulling production in the opposite direction. The production numbers should go negative in the near future as a result of the cost squeeze and supply disruptions flowing from this dynamic.

The chart that shows only industrial production and commodity prices is little more than a pitiful attempt at disinformation by the Fed and its professional apologists. It is a disingenuous, dishonest, and ham-handed effort to mislead the investing public into believing something that simply is not true. The idea that the Fed is not responsible for this mess is a lie, and they know it. But these are desperate times and they are desperate men. Be aware of this and act accordingly to protect your capital.

Source: How the Fed's Money Printing Is Linked to Commodity Inflation