Libyans have a new lease on life, a feeling that, at long last, they are the masters of their own fate. Perhaps Iraqis, after a decade of warfare, feel the same way. Both countries are oil producers, and there is widespread expectation among their citizens that that wealth will be a big advantage in rebuilding their societies.
Meanwhile, in Africa, Ghana has begun pumping oil for the first time, and Uganda is about to do so as well. Indeed, from West Africa to Mongolia, countries are experiencing windfalls from new sources of oil and mineral wealth. Adding to the euphoria are the historic highs that oil and mineral prices have reached on world markets over the last four years.
The prices of minerals, hydrocarbons, and agricultural commodities have been on a veritable roller coaster. Although commodity prices are always more variable than those for manufactured goods and services, commodity markets over the last five years have seen extraordinary volatility.
Countries that specialize in the export of oil, copper, iron ore, wheat, coffee, or other commodities have boomed. But they are highly vulnerable. Dollar commodity prices could plunge at any time, as a result of a new global recession, a hard landing in China, an increase in real interest rates in the United States, fluctuations in climate, or random sector-specific factors.
In the wake of the April oil well blowout off the coast of Louisiana, policy-makers are rethinking the issue of off-shore drilling. Clearly the last decade’s neglect of safety rules by federal regulators needs to come to an end. But what larger implications should we draw for domestic oil drilling?
The tension has long been between those who give primacy to the environment, on the one hand, and those who give primacy to business on the other. Probably some of the first group oppose all oil drilling and some of the latter support all oil drilling (even when the government unconscionably offers oil leases on federal lands at below-market rates, as it often has historically). As so often, the right answer lies in between. Continue reading →
The possibility that some Gulf states, particularly the United Arab Emirates, might abandon their long-time pegs to the dollar has been getting increasing attention recently (for example, from Feldstein and, especially, Setser).It makes sense.The combination of high oil prices, rapid growth, a tightly fixed exchange rate, and the big depreciation of the dollar against other currencies (especially the euro, important for Gulf imports) was always going to be a recipe for strong money inflows and inflation in these countries. The economic dynamism — most striking in Dubai –is admirable and fascinating as a longer term phenomenon, but also now clearly shows signs of overheating.Indeed inflation has risen alarmingly, as predicted. Among other ill effects, it is producing unrest among immigrant workers. An appreciation of the dirham and riyal is the obvious solution.
Everyone is looking for someone to blame for high prices of oil and other mineral and agricultural commodities. Speculators (among others) are high on the list, followed by the Federal Reserve. While I don’t think blame is necessarily the right concept here, I have been arguing that low real interest rates have worked to raise real commodity prices through a number of channels. Each of these channels could be called “speculation,” if speculation is defined as behavior based on expectations of future prices.
Fed Vice Chairman Donald L. Kohn in a speech yesterday, addressed a theory to which I am partial: the theory that low real interest rates have been a factor behind the continued rise in prices of agricultural and mineral commodities, including oil, over the last year.
The relevant excerpt: “Some observers have questioned whether the news on fundamentals affecting supply and demand in commodities markets has been sufficient to justify the sharp price increases in recent months. Some of these commentators have cited the actions of the Federal Reserve in reducing interest rates as an important consideration boosting commodity prices. To be sure, commodity prices did rise as interest rates fell. However, for many commodities, inventories have fallen to all-time lows, a development that casts doubt on the premise that speculative demand boosted by low interest rates has pushed prices above levels that would be consistent with the fundamentals of supply and demand. As interest rates in the United States fell relative to those abroad, the dollar declined, which could have boosted the prices of commodities commonly priced in dollars by reducing their cost in terms of other currencies, hence raising the amount demanded by people using those currencies. But the prices of commodities have risen substantially in terms of all currencies, not just the dollar. In sum, lower interest rates and the reduced foreign exchange value of the dollar may have played a role in the rise in the prices of oil and other commodities, but it probably has been a small one.” (Speech at the National Conference on Public Employee Retirement Systems, New Orleans, Louisiana, May 20, 2008).
If strong economic growth is not the explanation for the large increases since 2001 in prices of virtually all mineral and agricultural commodities, then what is? One wouldn’t want to try to reduce commodity markets to a single factor, nor to claim proof of any theory by a single data point. Nevertheless, the developments of the last six months provided added support for a theory I have long favored: real interest rates are an important determinant of real commodity prices. High interest rates reduce the demand for storable commodities, or increase the supply, through a variety of channels:
It is hard to remember now, but mineral and agricultural commodities were considered passé less than ten years ago. Anyone who talked about sectors where the product was as clunky and mundane as copper, corn, and crude petroleum, was considered behind the times. In Alan Greenspan’s phrase, GDP had gotten “lighter;” the economy was becoming weightless, “dematerializing.” Agriculture and mining no longer constituted a large share of the New Economy, and did not matter much in an age dominated by ethereal digital communication, evanescent dotcoms, and externally outsourced services. The Economist magazine in a 1999 cover story forecast that oil might be headed for a price of $5 a barrel.