Deep recession in 2023?

The chart below shows the deviations from trend of the CRB commodity price index, and of my index of world industrial production.  The CRB deviation from trend has been smoothed, inverted and lagged 18 months (i.e., plotted with an 18 months lag)

Why should rising commodity prices lead to a recession later on?

First, there is the income transfer.  When commodity prices double or quadruple, then the exporting country  experiences a jump in income, and consumers in importing countries experience a fall in (real) income.  The two should offset each other, but they do not.  Consumers have no alternative to reducing their spending when the prices of food and energy rise.  But commodity exporting countries do not need to spend the extra income they're getting.  Of course, they do eventually spend it, but the delays involved reduce world demand and output.

Second, a surge in commodity prices leads to a jump in general inflation, as rising commodity prices spill over into the rest of the economy.  Policymakers respond to rising inflation; Central Banks by tightening policy (raising interest rates, and reversing quantitative easing); governments by (perversely) tightening spending and raising taxes.  This especially applies to developing countries, which are more dependent on foreign borrowing to fund expenditure.  These countries often have no choice but to tighten fiscal policy.

Third, these tightening measures lead to a fall in asset prices, including commercial property and housing.  Often the decline in asset prices leads to banking crises and collapses.   A credit crunch is added to the original downward impetus, making the downturn even more severe.

These are general patterns ― the specifics in every cycle are different.  But it will do to go on with.

So a rise in commodity prices leads to a subsequent downturn in economic activity.  The relationship is inverted, and also lagged.  The effect of surging commodity prices isn't immediate, it lags ― by an average of 18 months, as the chart below shows.

Relative to its trend, the rise in commodity prices (plotted as a negative in the chart, because the effect of commodity prices increases is inverse to the effect on economic activity) is even larger than in 1972/73.  And that implies an even deeper recession than in 1974/75.

However, this is only one of possible indicators pointing towards recession.  I will examine others over the next couple of weeks.