Saturday, April 19, 2008

The Non-Mystery Of The Commodity Price Boom

Paul Krugman seems puzzled as to why for example oil reached a new all time high of $117 per barrel yesterday, and why commodity prices in general is soaring.

However, there is no puzzle. As I explained here, what is driving the commodity price boom is a combination of both monetary and non-monetary factors.


Blogger happyjuggler0 said...

It is disturbing he can't figure it out. In the event he stumbles his way over to here, here is how commodities economics works PK.

Commodities supply is highly inelastic. Commodities demand is highly inelastic. This leads pretty inevitably to boom/bust cycles lasting a decade or more on each side of the boom and bust. We still likely have a decade or so to go before we hit the bust, although each commodity's mileage will vary.

Any economist worth his salt ought to be able to figure that out.

Unless new materials and new energy substitutes come along, as opposed to mere efficiency gains, then this boom cycle is likely to last longer than "usual". The reason being is that finally a huge chunk of the world's population is figuring out that adding more economic freedom means economic growth.

Therefore in addition to the usual current developed world demand needing to be satiated with new supply, producers of commodities have to also supply a huge and growing amount of new demand in China, India, Viet Nam and huge amounts of other countries around the world. This demand isn't going to end, it is going to grow and grow and grow. It needs either an increasing amount of new supply, or substitutes.

The higher the price, the more likely substitutes will come along for the internal combustion engine (e.g. electric cars powered by new lithium batteries or perhaps a supercapacitor), as well as new compostite materials. Still, electric cars need electricity, so new supply would have to come online in a large way.

Finally, the developed world ought to overcome its phobia about nuclear power and follow in France's footsteps (85% of power is from nuclear in France). It will take time to bring new uranium supply online, but it also will take some time to get nuclear plants online too.

I also agree with your sentiment that monetary policy is a factor, especially US Fed policy.

The commodities boom also looks quite different in Euros or Yen than in Dollars.

Similarly agriculture demand is going to keep going up thanks to new developing countries moving up the food chain to meat that consumes about 10x as much grain per calorie as a vegetarian diet does. This too isn't going to stop. It doesn't hurt their cause that the dollar is cheap either since the US is a huge marginal supplier of food to the world.

Soon enough the world's farmers will slaughter huge amounts of livestock because it is too expensive to feed them. This will lower meat prices, leading to more slaughter. Once the slaughter ends however, meat prices will skyrocket. joining high grain prices, which will moderate for a time, but eventually both will simply grow higher and higher in price until supply keeps up with demand.

Flower prices ought to soar too by the way.

I see four basic solutions to ever rising food prices. First, all agricultural land in developed countries that is "set aside" due to idiotic agriculture policies must be brought online. This grotesque government failure simply must stop.

Second, one way or another, someone must depose malign dictators like Mugabe. Zimbabwe used to be called Africa's Breadbasket, and it will be called that again some day. It has fabulous soil and climate for growing food. But it needs farmers to actually farm the land. To do this they need a profit motive, on a risk adjusted basis no less. This means that whatever new government comes in after Mugabe is exiled or dead simply must have a credible free market policy.

Third, Europe should give up its idiotic phobia about geneticly modified food. This will radically increase yields.

Fourth, biofuels that come from food should either be banned, or at the very least, no longer subsidized. One might think that simply ending subsidies would be enough, but thanks to built up infrastructure, it is possible a new equilibrium will come about, depending on relative food and oil prices, whereby it makes sense to turn food into energy.

By the way, there is now a "consensus" that biofuels are worse than oil from a greehouse gas point of view. But this is neither an Iowa consensus, nor a Washington Consensus. Cough.

Waste products can be used for biofuels assuming the technology is profitable, but this is a drop in the bucket from a new energy source point of view, especially since the EROI on biofuels is pathetic.

10:27 PM  
Blogger happyjuggler0 said...

P.S. I almost forgot. Energy is a significant input into agriculture. Think in terms of diesel fuel, electrically powered irrigation, and in fertilizers. More so for greenhouse grown food which is popular during the winter with the backwards thinking "food miles" crowd who don't realize how energy intensive local out-of-season food is.

10:35 PM  
Anonymous Anonymous said...

How long do you expect it to last?

12:34 PM  
Blogger stefankarlsson said...

The non-monetary factors driving the boom will be around for a few more years. And most likely, so will the monetary factors.

9:25 PM  

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