Hamish McRae: Have we created a commodities bubble that could derail recovery?

Economic Life: The rise in commodity prices is, in some measure, the result of loose monetary policy

A puzzle: you don't trust the euro or sterling, for obvious reasons, but were it not for its reserve currency status the dollar would be pretty suspect, too. So where do you go?

Another puzzle: the world recovery is anaemic at best, so why have commodity and energy prices recovered so swiftly?

Now put the two puzzles together, and maybe there is an explanation. Could it be that concern about the long-term value of all currencies is pushing investment into anything and everything else, with oil, gold and other minerals in the front line?

There can be no definitive answer to this, but the arguments that there is some sort of link are persuasive. Oil first. The oil price has been pretty solidly above $80 a barrel in recent weeks, a level that the China Investment Corporation (CIC), the country's sovereign wealth fund, believes is too high. One of its senior officials said yesterday that commodity prices were outpacing the global economic recovery, and that this was being fuelled by loose monetary policies.

If the Chinese think that, this is important. China is, after all, the largest single source of additional savings in the world and is the largest importer of many commodities. There are, however, some reasons to suppose that for oil at least, demand from emerging markets will support the price, if not in the next few months, at least in the medium term.

The bear case for oil is that there will be a significant increase in supply over the next few years. The big Middle East producers, including Saudi Arabia, Kuwait and Iraq, have all got plans to boost production. Iraq is now producing more oil than at any time since 1990. Non-Opec producers, including Canada, Brazil and Angola, have also been increasing production. Meanwhile, demand from much of the developed world has been falling steadily. Oil consumption in Japan, Germany and France has fallen by 13 per cent since the peak in 1996. There is also, thanks largely to a general decline in demand as a result of the recession, huge over-capacity in oil production.

But this bear case seems to be being ignored by the markets. Why? The key argument is that global demand for oil, driven by the Bric (Brazil, Russia, India, China) economies, will go on rising. Actually we should not be surprised by this because even before the recession, most of the additional demand for oil was coming from the Brics – 60-80 per cent in 2006 and 2007. This year, in all probability, the world will use more oil than ever before. And that is at the beginning of the next phase of global growth.

Put these two together and where do you get? My own feeling squares with that of Chris Watling, of Longview Economics, and that of the China Investment Corporation. It is that fundamentals of supply and demand do not support the rally in prices. What I am less sure about is how far you can go on with the second part of the CIC argument and attribute the surge in prices to the loose monetary policies of the West.

Have near-zero interest rates and quantitative easing pushed up UK house prices? Undoubtedly. Have they, together with similar policies by the Federal Reserve and the European Central Bank, also pushed up oil prices? Not so sure.

Move on from oil to other commodities. Industrial metals are around 80 per cent of their level of mid-2008, having fallen to well below 50 per cent early last year. Copper has been trading in the same broad band that it did in 2006-08, during the height of the boom. Precious metals are well past their previous peak, with gold in dollar terms securely above $1,000 an ounce since the autumn. Yesterday it was around $1,130, off a little on the day but still remarkably strong by historical standards, and this despite the stronger dollar.

By contrast the Baltic Dry Index, which tracks prices for shipping commodities around the world and therefore gives a snapshot of what is happening to world trade, has hardly recovered at all. It is off the floor but is still at a level that is causing great pain to the shipping industry. There are huge numbers of ships laid up and many more steaming slowly to conserve fuel.

My rough and ready rule-of-thumb from all this is this: the more useful anything is, the less it has risen in price. Thus the closer any indicator is to the real economy the less it has risen, and the closer any indicator is to pure speculation the more it has risen. So at the extreme, shipping rates have secured only a modest recovery; at the other extreme gold has gone mad. Copper is in the middle. It is useful for industrial purposes but is also, in some measure, like gold and therefore a store of value too.

So, yes, the rise in commodity prices is, to some extent, the result of loose monetary policy. You can have a debate about how far this is true but it is impossible to deny that loose policies have had some effect. The next question is to what extent this mini-commodity boom will derail the recovery, or at least hold it back. We knew, or at least we expected, that very loose monetary policies would lead to asset inflation – the recovery in property prices and share prices more or less everywhere – and that was seen as either an objective, or at least a price worth paying. What I don't think would have crossed the minds of the designers of monetary policy is that it might also lead to a surge in commodity prices.

There is one thing we can, I suggest, be pretty sure about. Commodity and energy prices will tighten further as global demand recovers. The best hope is that the speculative element supporting prices at the moment will give way to price support from real demand. In other words, as monetary policy gets back to normal, people will no longer feel the need to hold commodities as a store of value and will be happy to hold monetary instruments instead. So as the world economy grows and real demand for raw materials and energy rises, speculative demand will fall.

There is, however, a less attractive possibility. It is that the recovery will falter, the fiscal and monetary authorities in the developed world will not get policy back on track by cutting deficits and increasing interest rates, and people will lose faith and pile even more heavily in to anything that gives a store of value. So commodity prices will rise even further.

I don't think it is possible to see with any clarity how this commodity mini-boom will play out. What can be said is that it is a warning that loose monetary policy carries costs. The Chinese are right about that. And I think you can also say that this coming recovery will be characterised by a squeeze on the supply of both raw materials and of energy.