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Saturday, June 28, 2008

Krugman 3, Free Market Economists 0

I am sorry to say that I still think Krugman is crushing all of the other econowizards on speculation and oil prices. To recap very quickly: Krugman originally said that if speculators were raising prices above the level justified by "fundamentals," then clearly there would be a surplus of oil on the spot market. This is possible, but it would require somebody to be stockpiling the oil. We don't see this in the inventory data.

OK Tyler et al. come back and say, "No, it could be that producers hoard the oil in the ground, i.e. they pump less today and plan on pumping more in the future."

Then Krugman can come back and say, "Right that's possible, but even in that case you would see futures prices higher than spot prices--i.e. contango. And yet the oil market has been in backwardation for long periods during oil's runup."

Now here is where it gets ridiculous. Tyler actually said:

[W]hen risk and liquidity premia are changing, the relationship between the spot price and futures price is obscure and difficult to interpret. In particular a futures price for oil below the spot price does not refute the speculation hypothesis or even provide much evidence against it.

On MR I posted my thoughts on this technically true, but in practice ridiculous, rhetorical move:

"If you can sell oil at $140 today, or you can short a futures contract and sell it in one year at $130, what oil producer would do that? The only liquidity or risk story you could tell is that you are afraid nominal interest rates will go negative, and that roving mobs will empty your bank but not your oil field."

One last point: The context of Tyler's remark was Arnold Kling's analysis of the "option value" of keeping oil in the ground. E.g. if spot oil is $140 while the futures price for oil next year is $130, an oil producer might still keep some barrels in the ground because of the possibility of oil jumping to $150 by next year.

That's fine. But then it's not the institutional investors who are driving the price hike! In fact, by construction in this example, the people trading futures contracts are tending to dampen the amount of oil that producers store for future sale. So sure, you could say "speculation" is causing the price hike, but that is a tautology (and in fairness Kling admits this, sort of). But that's not what Krugman--or Michael Masters--means when asking, "Are speculative investors responsible for oil doubling in a year?"

(BTW if anyone hasn't been keeping up with this stuff and wants a roadmap of the exchanges, go to Tyler link above.)

3 comments:

  1. richard face1:38 AM

    I will go back through the links but I am just curious, are Kling and Cowen saying that speculators are causing high oil prices AND that is something illicit that the government should interfere with?

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  2. I'm not sure what Kling's overall view is, but no, Tyler doesn't think speculators are doing it. He disagrees with Krugman's arguments for this conclusion, however.

    (I forget what reasons prompt Tyler to this conclusion, if he thinks inventories and oil yield curve are irrelevant. I think he lays it out in the post I linked to, though.)

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