12 Krugmans could have saved the world economy

I have some recent posts bashing Krugman and his pal DeLong.  So maybe it’s time to show that I can be just as “fair and balanced” as Fox News, er, I mean NPR and the BBC.  This won’t be entirely positive, but I think Krugman fans will be very pleased by the ending.  (Bob Murphy may want to skip this one.)  Let’s start with three recent posts by Krugman that show him fighting the good fight against the forces of reaction:

Here Krugman discusses changes in the price of the median good within the CPI.  Back in the days before I decided that inflation was merely a human construct with no relationship to “reality,” and of no real use for anything, I also thought that the median CPI price might be one way to get at the underlying forces of inflation and deflation.  And the most recent data shows that while the headline CPI has been rising since early in the year, the more meaningful median CPI has been falling, down to about 0.5% in September.  I see the median as best representing purely monetary forces, as it shows the point where one half of all goods rose at a slower pace, and one half rose at a faster pace.  I agree with Krugman that this is a better indication of the future course of the CPI than the headline rate.  And the two-year CPI futures and TIPS markets also seem to agree.

This post suffers from some of the same flaws as the China editorial I just criticized, but does make one good point.  If the Chinese were to dump US assets and buy some other assets (say European government bonds) it would tend to depreciate the dollar and could actually boost the US recovery. 

And finally in this post he bashes all those right wingers who keep clamoring for tighter monetary policy in the US.

The thing that is so frustrating about Krugman is that he can be so correct in his analytical approach to money, and yet fail to emphasize the logical implications of his analysis; money has been far too tight in the US over the past 14 months.  But first let’s look at three big positives:

1.  Krugman correctly argued that tighter money would be a bad idea in mid-2008 and again today, and has been bashing those at the Fed who keep itching to tighten policy.  That’s one feather in his cap.

2.  Krugman understands that even at the zero bound a central bank still has options.  They can set an inflation target high enough to lower long term real interest rates.  Here I’ll only give him 1/2 feather, because he’s been remarkably shy about publicizing this point.  But at least when he has done so, he ‘s indicated that the Fed should have a higher inflation target.

3.  Many economists, including Krugman, did research showing various ways out of the liqudity trap; but he has been the most vocal in arguing that it isn’t as easy as it seems, and that we could easily make the same mistakes as Japan.  I thought Bernanke would have done better, and should have done better.  But the fact remains that Krugman was right and I was wrong, policymakers have reacted pretty much as he forecast.  So there’s another feather.

Krugman’s argument for fiscal stimulus still strikes me as wrongheaded.  He is essentially saying the following:

1.  Unconventional monetary policies might work at the zero bound.

2.  Conventional monetary stimulus cannot work at the zero bound.

3.  Central banks are too conservative to promote unconventional stimulus though inflation targets.

4.  Ergo, monetary policy is ineffective at the zero bound.

My number 4 would be “Ergo, we should all start screaming at the major central banks to be less conservative.”  Indeed, the only effective monetary policies at any time, zero bound or not, are those that change the expected future path of policy.  So in a sense Krugman’s argument is nothing but the banal observation that when monetary policymakers refuse to do effective policies, policy will be ineffective.

But let’s end on a positive note.  Suppose the FOMC in 2008 had been composed of 12 Paul Krugman’s.  If we can take him at his word, and I don’t see why not, he would have been much more aggressive in easing during the crucial months in mid-2008.  And then when it became apparent that there was a threat of deflation, I could easily see Krugman setting a fairly expansionary inflation target.  He has frequently discussed the need for high inflation expectations in a liquidity trap.  Here I think it might be helpful to briefly go back to the Great Depression, and see what FDR did.

In 1933 FDR shocked the world by devaluing the dollar when the dollar was under no pressure at all.  Sure, other countries had already devalued, but they generally did so when their currencies had been under speculative attack.  We had the world’s largest stock of gold in 1933, and by the time of the late April devaluation the brief run on the dollar at the end of the Hoover administration seemed like ancient history.  Even worse from the perspective of respectable opinion, he kept devaluing long after others (including even Keynes) said he should stop.  Now we have Krugman calling for even further dollar depreciation at the very moment everyone is panicking about a weak dollar.

At the World Monetary Conference of June 1933 FDR essentially gave the middle finger to right-wing monetary and financial experts all over the world, and said something to the effect that: “Monetary stability isn’t stable exchange rates, it’s price stability.  But first we need to return prices to pre-depression levels, and then stabilize them.”  And he relished doing this.  Do people like Bernanke and Svensson have the personality to do something equally controversial?  I think you know the answer.  But given how Krugman feels about the right-wing forces calling for tight money despite market expectations of ultra-low inflation and near double-digit unemployment, and given Krugman’s, how shall I put it, somewhat combative personality, I could see him in the FDR role.  And then we never would have even needed the $800 billion dollar stimulus package.  I bet you never thought I’d have a post with a title like this one, where I wasn’t being sarcastic.  If you know a Krugman fan, please pass it along.  As Rodney King said: “Why can’t we all just get along?”


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24 Responses to “12 Krugmans could have saved the world economy”

  1. Gravatar of Greg Ransom Greg Ransom
    24. October 2009 at 13:36

    The “right wing” descriptor isn’t helpful — Friedman & Hayek both believed Fed policy was too deflationary in the 1930s and many Austrians think the Fed needed to accommodate increasing demand for money in late 2009.

    You’re misleading people by using this language.

    Side note — you Ned to send Bruce Bartlett a note explaining why the Fed isn’t in fact out of arrows. Right winger Barlett is calling for massively expanded fiscal spending to cure the liquidity trap because “the Fed and monetary policy can’t do it”.

    Check Bartlett’s blog for details.

    And yes Bartlett is a right winger.

  2. Gravatar of Greg Ransom Greg Ransom
    24. October 2009 at 13:37

    Make that:

    “and many Austrians think the Fed needed to accommodate increasing demand for money in late 2008″

  3. Gravatar of David Pearson David Pearson
    24. October 2009 at 15:39

    Scott,

    If the Fed told the market explicitly that they are targeting median CPI rather than headline, the market would respond by forecasting a longer tenor for ZIRP, and would bid up most commodity prices through the carry trade.

    So in the end, you’ll get higher oil prices, lower real wages, lower consumer spending, and some positive export growth (as real wages decline). Will the export growth make up for the impact of lower real wages on domestic consumption? Unlikely.

    In the end, it comes back to not-well-developed assumptions. How do QE and ZIRP produce self sustaining real growth? You haven’t answered that question, to my knowledge. What you have said is that the Fed should not let NGDP collapse. Fine. NGDP for next year is now running at around 3-4% — hardly a collapse. You might argue it still signals too-tight monetary policy, but that is not the same thing as arguing that a looser policy will lead to real growth. Again, raising headline CPI without boosting real growth (and, hence, real incomes) will weigh on domestic consumption. How do you get around that? With oil at $80 and unemployment at 10%, one could argue that the Fed is getting the worst of both worlds through its ZIRP policy.

  4. Gravatar of q q
    24. October 2009 at 16:36

    krugman has on at least two occasions quoted a somewhat sketchy goldman sachs report when writing about quantitative easing. i think he wants some kind of okun’s law correlation coefficient — something like “if the fed increases the size of its balance sheet by X that will cause the output gap to fill by Y%”. the study shows/showed (or his quoting of it) that it would take a $10T balance sheet to accomplish this.

    so if i understand him here, he’s said yes, do quantitative easing but expect it to be helpful not sufficient in the quantities you anticipate.

    what’s your okun’s law — how would you determine the size of QE?

  5. Gravatar of rob rob
    24. October 2009 at 18:32

    Scott,

    You have lost your mind!

  6. Gravatar of StatsGuy StatsGuy
    24. October 2009 at 21:30

    The primary threat from massive dollar devaluation may be commodity price surges… Nouriel Roubini discusses this:

    http://seekingalpha.com/article/168497-nouriel-roubini-one-on-one-more-doom-and-gloom

    I’m not entirely sure how this plays out, though. Honestly, I think the far worse threat is the _anticipation_ of devaluation, which causes an anti-dollar carry trade (and disinvestment from the US). If we could get the dollar devaluation over and done with, then – assuming we could eliminate the expectation of future devaluation – the dollar becomes a one way bet and investment funds flow back _in_ to the States. Moreover, the carry trade vanishes (and arguably, oil comes back down, since – as Roubini notes – the fundamentals do not yet support 80-100 dollar oil).

    But all of this is very hard to anticipate.

  7. Gravatar of Daniel Kuehn Daniel Kuehn
    25. October 2009 at 03:41

    Greg Ransom -
    If Friedman and Hayek were representative of the right wing, we’d be in a much better place.

    Which Austrians advocated accomodative monetary policy in 2008? I hadn’t heard that.

  8. Gravatar of Bill Woolsey Bill Woolsey
    25. October 2009 at 04:36

    Scott:

    Targeting the growth path of nominal expenditure — yes

    Inflation targeting — no.

    Promising to return nominal expenditures to its long term growth path so that profit maximizing firms are motivated to either raise prices or raise production–yes. (And the goal is that they raise production rather that prices, but they will do what they think best.)

    Promising a larger increase in the price level from its current level so that the real interest rate is more negative so the real volume of expenditures grow more rapidly, no.

    These are fundamentally different perspectives in my view.

    It is past time to stop trying to craft a sensible view in a way that it is half-way consistent with wrong headed dominant view.

    Here is how I see that wrong headed view. On aggregate demand, higher expected inflation lowers the real interest rate and that is what expands the real volume of expenditures.

  9. Gravatar of ssumner ssumner
    25. October 2009 at 05:34

    Greg, You said,

    “The “right wing” descriptor isn’t helpful — Friedman & Hayek both believed Fed policy was too deflationary in the 1930s and many Austrians think the Fed needed to accommodate increasing demand for money in late 2009.

    You’re misleading people by using this language.”

    Sorry, but I disagree. I didn’t say all right-wingers think money is too easy, but rather those who do are overwhelmingly on the right. I’m pretty sure people weren’t mislead, as anyone who reads this blog knows that I am a rightwinger, and that I have cited others on the right who agree with me about monetary policy. In intellectual discourse all distinctions between left and right are only approximate, and I think that is generally understood.

    I thought Bartlett was no longer a right-winger, but was now a fan of big government and higher taxes to fund that big government. Is that impression wrong?

    greg#2, Can you cite any specific sentence of mine that is wrong or misleading? If so I’ll change it.

    David, You said;

    So in the end, you’ll get higher oil prices, lower real wages,

    This is exactly what you want. The dollar devaluation of March to July 1933 pushed up commodity prices sharply. The WPI rose 14%, and since nominal wages were steady the real wage fell by about the same. A perfect test of my sticky wage theory against the Keynesian consumer spending theory. And during those 4 months industrial production rose 57%. The biggest real wage increase in the 20th century occurred in 1920-21, and industrial production actually fell about 30%. Why? because the huge real wage increase (defined as W/WPI) occurred because the WPI plummeted. So I am very comfortable with the fact that stimulus reduces real wages in the short run. It gives firms an incentive to hire more labor.

    q, You are right in one sense, he quotes G-S studies that are worthless as they don’t account for ther simultaneous decision to add reserves and start subsidizing reserves. But I am talking about something entirely different from QE. I am talking about an aggressive inflation target, which I believe Krugman thinks would be much more effective than QE. Those are two distinct policies.

    rob, Yeah, I’ve been doing that a lot recently. :)

    Statsguy, I find your remarks both very interesting and very confusing. In the Great Depression I found that actual devaluation helps a lot but expectation of devaluation often hurts. And this confused me. That’s why I find it so interesting that you intuition led you to a result that I found, but had trouble explaining. But the explanation I did come up with in the end required a gold standard. Expectations of devaluation led to gold hoarding which was deflationary. But none of this should happen under flaoting rates, the mere expectations of future depreciation of the dollar should cause it to depreciate right now.

    On commodity prices, check out my earlier response to David. I should amend my comment by agreeing that commodity price shocks for imported commodities can cause some problems for the economy. But when all is said and done aren’t commodity prices procyclical? So if my crystal ball told me oil would be $147 again in six months, I think “great, the world economy will again be booming.”

    Daniel, I agree about Friedman and Hayek. I think Greg is referring to those Austrians who think monetary policy should offset velocity declines–people like George Selgin. I don’t know his precise views on 2008, but he was pretty sympathetic to my argument in our recent debate. So I think Greg may be right about Selgin and other Austrians of that view. The more vocal group of Austrians that dominate on the internet are often much more “hard money” types.

    Bill, I agree but here I wasn’t trying to sketch out the optimal monetary response to the shock, but rather try to argue that Krugman would have responded more aggressively. I don’t think he is a strict inflation targeter, as he said that the high inflation in the first half of 2008 was misleading and that the real problem was recession. So he’s a guy that looks at both inflation and real growth. (But not NGDP per se.)

    I think he is wrong about the need for very high inflation expectations, so I agree with you there, and indeed I’ve devoted a couple posts to criticizing him and others on that issue.

    This post was low on economic content and instead focused on the political side of doing an aggressive monetary stimulus when most of the world thinks it would be too extreme.

    FDR knew much less economics than Krugman, and his reasoning was often flawed, but (until late 1937) his monetary policies were pretty good. And were enacted in the teeth of a lot of opposition from conventional wisdom. (Just don’t let FDR or Krugman decide on labor policies like minimum wages.)

  10. Gravatar of Bob Murphy Bob Murphy
    25. October 2009 at 08:53

    (Bob Murphy may want to skip this one.)

    You had me at the post title.

  11. Gravatar of Greg Ransom Greg Ransom
    25. October 2009 at 09:32

    My understanding is that Bartlett still favors limited government, but he no longer thinks that tax cuts work in the current historical moment the way they did under Reagan. He now believes that cutting taxes without cutting spending is fiscLly irresponsible, where it wasn’t in the 70s and 80s.

    Barlett has adopted the view of 1970s “conservatives” who were happy to be
    the tax collector of the kleptocratic state.

  12. Gravatar of Mark Mark
    26. October 2009 at 03:48

    Good squaring of the circle where your views overlap with Krugman’s. This blog as a platform to push through your views on price-stability and inflation is why I come here!

  13. Gravatar of ssumner ssumner
    26. October 2009 at 04:05

    Bob, Don’t worry, I be back to “bashing” Krugman soon.

    Greg, Yes, that’s probably right. But it doesn’t account for the fact that G/GDP fell in the 1990s under a Democrat, just as the Reaganites hoped. Nor does it account for the fact that the recent increase in G/GDP occurred under a Republican President (Bush II).

    Thanks Mark.

  14. Gravatar of StatsGuy StatsGuy
    26. October 2009 at 19:44

    ssumner: “But none of this should happen under flaoting rates, the mere expectations of future depreciation of the dollar should cause it to depreciate right now.”

    None of it technically should, but it appears to be happening for a couple reasons:

    1) The dollar/Yuan relationship is anchoring an overvalued dollar, and this is being enforced by currency controls. Arbitraging against the dollar is a one-way bet; eventually, the Yuan seems like it will need to appreciate (although, I’ve lately been wondering this – China might very well inflate/devalue its own way back to parity with the dollar).

    2) As I think we’ve discussed earlier, there are highly polarized opinions about the future status of the dollar, with some people expecting deflation and others hyper-inflation. Thus, the dollar has been bouncing around a lot, but can’t seem to “decide” where it really should go. This creates risk.

    3) Rorty, whose a finance guy, had an interesting article a while back on Baseline about the Limits of Arbitrage. The basic argument is that theoretical arbitrage opportunities can be limited by real world credit access limitations.

    So basically, a lot of this just boils down to the following insight:

    The dollar is too high relative to the Yuan, but I can’t arbitrage directly (capital controls) so I arbitrage indirectly by borrowing money in US dollars (at low rates, thus soaking up some of that liquidity we’re trying to force into the system). I take my borrowed US funds and buy commodities that I hold onto, thinking that when the Yuan revalues, I can sell the commodities (like oil) in Yuan, and buy back my dollars cheaply. That’s the carry trade (or, at least, one of them).

    But shouldn’t this trade play out and arbitrage close the gap? Somewhat, yes – and it has. A HUGE amount of leveraged money has been soaked up into “investments” just holding commodities (and keeping input prices higher) while end-user products are under downward price pressure. Also, there are limits to arbitrage (liquidity, credit markets) and the existence of the trade creates risk (which has a price – indeed, you can measure it in the risk premium associated with swaps).

    Alternatively, think of it this way – the “investment” in holding commodities as a hedge means we have investment banks paying to store oil in offshore tankers as an arbitrage mechanism. That’s a large deadweight loss which is being paid by someone, and the fact that someone is willing to pay that cost implies that “cheap” arbitrage has not fully closed the game – which means that any long term investment in the US already has one strike against it. (One could argue that gold could serve as the conduit for the carry trade, and it is, but it just can’t absorb the liquidity. Markets like equillibria at the margins, and so all the carry trade vehicles like to move together.)

    BUT, the “Strong Dollar” gurus have everything precisely backwards in their recommendations on how to solve the problem. Heightening interest rates to kick the dollar up is NOT sustainable long term. It might buy some (very costly) temporary relief from high oil prices, but in the long run will only intensify the expectation that the US will have to monetize more debt to recover lost ground (which will intensify the carry trade and disinvestment in the US). (BTW, this disinvestment in the US is being seen as inflationary pressure in places like Hong Kong, Singapore, etc. where real estate markets are booming and governments are not taking administrative measures like increasing down payment requirements.)

    Intervening to support a dollar will further cripple exports, kill more jobs, bloat federal support program costs, and cut federal tax revenues – virtually guaranteeing that the future adjustment to the dollar will be worse. In order to justify this, you would have to believe that oil/imported commodities are _so_ important that they have status on par with a Giffen Good.

    … so, without pretending to be coherent due to lack of sleep, those are some thoughts

  15. Gravatar of StatsGuy StatsGuy
    26. October 2009 at 19:46

    “where real estate markets are booming and governments are not taking administrative measures” should read “governments are NOW taking administrative measures”

    sorry

  16. Gravatar of D. Watson D. Watson
    27. October 2009 at 09:40

    Do we need 12 of them? Here and elsewhere there is very little discussion of the views of the other members of the board and their effects over the last 30 years (exception: you took exception to a hawk’s hawkishness). It’s Volcker this, Greenspan that, and Bernanke the other. Would things be different if we had just one Krugman and he was in charge? Based on Bernanke’s earlier writings, which you cite the same way you do Krugman’s (he wrote this, so why is he acting like he doesn’t believe it?), I don’t know that it would change much.

  17. Gravatar of ssumner ssumner
    27. October 2009 at 15:31

    Statsguy, You said;

    “BUT, the “Strong Dollar” gurus have everything precisely backwards in their recommendations on how to solve the problem. Heightening interest rates to kick the dollar up is NOT sustainable long term. It might buy some (very costly) temporary relief from high oil prices, but in the long run will only intensify the expectation that the US will have to monetize more debt to recover lost ground (which will intensify the carry trade and disinvestment in the US).”

    I agree, their solution for high commodity prices is more recession. It is true that recessions lower commodity prices, and depressions even more so. But at what cost? As you say these policies simply open the door for something much more radical in the future, like monetaizing the debt. Conservatives are their own worst enemies, as they were in 1932. We need a happy medium.

    I’m not sure I quite follow your oil hoarding story. Where is the market failure? Maybe you can redo it when you get some sleep.

    D. Watson, You may well be right, but the key part of my argument are that Krugman is more pro-stimulus, and more importantly is much more combative than Bernanke. I like Bernanke better personally, but he doesn’t strike me as a particularly assertive figure. The 12 Krugmans title was a bit of hyperbole–you do need diversity on a decision–making body.

  18. Gravatar of StatsGuy StatsGuy
    27. October 2009 at 17:38

    I’m clearly not explaining this well…

    The carry trades _are_ the mechanism by which currency arbitrage is taking place. In that sense, it’s not a “market failure”. However:

    1) Direct arbitrage is impossible due to capital controls
    2) Thus, we have indirect arbitrage. This requires the use of various vehicles to hold value over time until capital controls are removed
    3) The various vehicles that can be stores of value are not all cheap to store or use; vehicles that are efficient stores of value (gold) simply cannot absorb all the liquidity that is seeking to participate in the carry trades
    4) The fact that some participants in the carry trade are willing to spend a lot of money to store things like oil (or iron ore, in the case of China) proves that arbitrage is costly, and therefore incomplete
    5) Since arbitrage is incomplete (for a host of reasons), this means there is a remaining expectation of future devaluation.
    6) This is an implicit tax on US dollar denominated investments, and deters such investment.
    7) Awareness of this tax also creates an expectation of low investment (and low growth), and hence has a negative “multiplier” effect.
    8) The best fix is to remove the source of the problem by getting the necessary devaluation over and done with

    Separately, and secondarily:
    In addition to the above, the use of _real economic inputs_ as stores of value in the carry trades _does_ support prices, but the price support is extremely uneven. Current prices reflect the thing’s property as a store of value rather than just its value in the production/consumption chain; however, oil’s use as a store of value is limited in duration (until the source of the carry trade – the currency imbalance – is rectified).

    In other words, oil (and other things) have temporarily taken on certain properties of money, and this causes price distortions that are temporary and artificial. That’s what (I think) observers mean when they say a new bubble in oil is forming.

  19. Gravatar of ssumner ssumner
    28. October 2009 at 17:32

    Statsguy, You said;

    “The best fix is to remove the source of the problem by getting the necessary devaluation over and done with”

    Isn’t the source of the problem the capital controls? In addition, what you describe sounds like a problem for China, not the US. Isn’t it the Chines ewho are trying to evade the capital controls? US citizens are free to speculate in whatever they want.

    You lost me at the last sentence. If this is correct, then we should have data on production, consumption, futures prices, etc, to support the hypothesis. Production should be much higher than consumption, and futures prices should be much lower than spot prices. Are they?

  20. Gravatar of ssumner ssumner
    28. October 2009 at 17:34

    Statsguy, One other point. Exchange rate policy is essentially monetary policy (even if the current money supply is unaffected.) The last thing we want to do is subordinate monetary policy to what is going wrong in some corner of a commodity market.

  21. Gravatar of StatsGuy StatsGuy
    28. October 2009 at 20:39

    ssumner:

    “Production should be much higher than consumption, and futures prices should be much lower than spot prices. Are they?”

    The answer to the first is yes.

    Here is some data on oil, specifically:

    total stocks:

    http://tonto.eia.doe.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=MCRSTUS1&f=M

    Oil prices:

    http://www.wtrg.com/daily/clfclose.gif

    So even though production is declining (due to Opec Cuts), consumption is declining even more and total stocks set a new historical norm (in the midst of a recession when all other industries were cutting inventory).

    On the second hypothesis (futures prices lower than spot prices), why would you expect that? While the oil market did experience that in 2006 (a condition called Contango), I wouldn’t expect the Carry trade to cause that.

    If I expected the dollar to suddenly plummet vs. the Yuan in 2012, then (in the absence of arbitrage) I would expect a sudden increase in dollar-price of oil in 2012. And if oil was expensive to store (which it is), then I would pay more for the future contract for oil in 2012 than for oil right now… And that’s the case.

    But, that’s a normal condition of the futures market. Perhaps the more interesting thing is the gap between the spot and futures price. This gap widened during the mass deleveraging when the dollar was appreciating (indeed, the reversal of the dollar/yen carry trades helped the dollar appreciate). But then the gap started to close rapidly – not from futures dropping, but from spot prices spiking (even though consumption remained well below the already-reduced production, and stocks continued to grow).

    http://www.durangobill.com/OilChart.gif

    Note the gap that emerges between the Red line (near term price) and yellow line (most distant price).

    But that can also be explained by arguing the economy/demand would pick up, so it’s not conclusive of much.

  22. Gravatar of StatsGuy StatsGuy
    28. October 2009 at 20:59

    ssumner:

    “Isn’t the source of the problem the capital controls?”

    Yes, and if they went, the Carry Trade would disappear as the dollar instantly hit its natural value. Then the Fed could devalue further as needed (and so could China).

    The real problem isn’t that oil prices are so high, but they are high _relative_ to output prices. Right now, the dollar is overvalued, so US exporters earn less on their exports, BUT due to the carry trade they pay high costs on inputs. That’s a “bad” kind of inflation, because of the imbalance.

    There is no carry trade in manufactured outputs, or agricultural outputs, because many degrade in value over time (a computer chip starts getting less valuable the moment it’s made, food rots and gets eaten by bugs/mice). They cannot be easily arbitraged.

    ssumner: “The last thing we want to do is subordinate monetary policy to what is going wrong in some corner of a commodity market.”

    Subordinate, no, but perhaps take into account? I’d rather have the Fed devalue even with the carry trade than hold to tight money to keep oil prices low (among other things, this is the closest thing we’ve had to an energy policy for 20 years!), but the best option is that the Fed devalues in the absence of the carry trade. That requires China abandoning the peg/capital controls – and China is free to devalue using normal mechanisms (e.g. printing money, low interest rates, etc). Let everyone devalue!

    But lately, I’m starting to think that China’s plan is to hold the peg, and then expand money as fast as it darn well can, until the value gap is closed… meanwhile, diversify away from its dollar reserves and its dependence on US imports.

  23. Gravatar of StatsGuy StatsGuy
    29. October 2009 at 06:07

    Also, quick apology – in 2006, that was backwardation, not contango.

  24. Gravatar of Scott Sumner Scott Sumner
    30. October 2009 at 11:23

    Statsguy,

    1. If you look at the numbers in the table of oil stocks, the levels were lower in June/july 2008, (when prices peaked) than in the same month of 2007, 2006, or 2005. So I don’t see how you can claim oil hoarding was pushing up prices.

    2. Those are US stocks, not world stocks
    3. The forward price is substantially higher than the spot price, so I don’t see how speculation can explain the spot price. Speculators obviously think this demand upswing is real, and prices will go higher. So spot prices should be rising in that case (according to economic theory) as it will encourage conservation and allow more oil to be available in the future when prices are higher.

    statsguy#2, This is a carry over from the previous point. Because I’m not convinced about your oil story, I don’t know whether we should focus on the problem of rising input prices. I agree that it makes things a bit more difficult for our economy, but I see it as the market’s understanding that once the world economy recovers, the fact that the Chinese are now buying more cars than Americans means that somewhat higher oil prices are here to stay. I think the problem goes beyond these monetary/exchange rate/current account issues. But I guess we both end up favoring easier money in the US, so perhaps it doesn’t matter that much how we get there.

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