Judging from some of the reactions across the blogosphere (not to mention any number of our own dear readers), maybe I should take another stab at clarifying why I see the hand of the Federal Reserve in the most recent movements in oil and commodity prices.
Let’s start with Free Exchange, who had this to say:
JAMES HAMILTON is an excellent economist and blogger [thank you kindly], but he’s confounded me today. In a post examining the roots of the recent surge in oil prices, Mr Hamilton displays a number of charts which seem to clearly indicate the extent to which petroleum production has stagnated– not just in recent months, but over the past few years– even as global demand growth has proceeded apace. He then goes on to note that this has practically nothing to do with increases in oil prices.
Then please permit me this opportunity to clarify. Stagnating oil production in the face of strong demand has everything to do with the broad run-up in oil prices since 2001, as we’ve been saying over and over from the very beginning of this blog. My claim that the Federal Reserve has now also started to contribute to the most recent oil price increases is very specific to what we’ve observed since January of this year, as I clarified when I first raised this issue February 28:
Although I have been skeptical of Jeff Frankel’s story that low interest rates were the primary cause of the broad movements in commodity prices over the last several years, it is very plausible to me as one explanation of what we’ve seen happen over the last two months.
And here’s what I said on March 28:
I have long argued that the broad increase in commodity prices over the last five years has primarily been driven by strong global demand. But I am equally persuaded that the phenomenal increase (,
) in the price of virtually every storable commodity in January and February cannot be due to those same forces. This was a period when the economic news was getting bleaker by the day, eventually persuading many of us that a recession has likely started. To argue that January and February’s news instead signaled booming commodity demand strains credulity.
Paul Krugman, Lawrance Lux,
and two Angry Bears
are also skeptical of my claims. Some weeks back Paul noted that, if commodity speculation is playing a role in price moves, we should be seeing inventory accumulation. He appealed to a diagram such as the one below, which depicts the supply and demand curve in the absence of any inventory changes or speculation. Krugman noted that if speculation succeeded in driving the price above the fundamentals equilibrium price P0, it would produce a gap between supply and demand, and would have to show up as inventory accumulation.
But where, Paul asked, is the current evidence of that inventory accumulation? On Sunday, he answered his own question with this graph of metals inventories:
But again, I agree with Paul and the others above that speculation was not the primary factor prior to January, and I draw the same conclusion they do from the historical graph. But in terms of interpreting the trends over the last few months, let me just note that the very short run supply and demand curves for most of these commodities are extremely steep– there is practically no way to bring more copper to the market over the next few weeks unless you are bringing it out of storage somewhere. And if those curves are extremely steep, the magnitude of the inventory change you’d expect would be quite small. Particularly since it could show up anywhere in the chain from production to consumption, I don’t think there’s a strong presumption you could find evidence of it in the available data.
No matter what your favorite explanation might be– whether speculation or fundamentals of supply or demand– any coherent theory says these shifts should show up somewhere in quantities produced, consumed, or stored. But given the very low short-run supply and demand elasticities and the quality of available data, hoping to find confirmation or refutation of that theory on the basis of the quantity data may be asking too much. I believe we have to rely on something else to persuade us. And the main thing that makes me doubt the demand-based story is the fact that the latest surge in commodity prices– that since January– came at a time when every indicator of which I’m aware pointed to slower rather than faster real economic growth.
The Free Exchange piece quoted above ends up with the following conclusion:
I predict that if the Fed did surprise by holding the rate steady, oil might crash–all the way back to $100 per barrel.
Again, that’s not so different from my own views. Except that I’d add that $100 a barrel would be a welcome development at the moment. If it’s within the Fed’s power to achieve that, the opportunity should be seized with enthusiasm.