Whatever happened to the commodity standard?
It used to be common, in the late 80s and early 90s, when inflation fighting was still the top concern of policy-oriented macroeconomists, to read calls for a return to a commodity standard. The Wall Street Journal, in particular, liked the gold standard, but eventually was willing to settle for a basket of commodities. Only, they gave it up in the 90s when commodity prices fell drastically. The Economist’s commodity index stood at 60% of the 1990 values at one point in the late 90s (in dollar terms – the Euro decline was never so drastic, in part because the dollar rose.) The Economist had done a milder version of the same thing: first arguing for a “hard” standard, then slinking away silently when the standard turned out to be too soft for their liking.
What this episode revealed is that these two conservative, business-oriented publications are mainly interested in keeping finance scarce. They may find lots of arguments convenient along the way because these arguments take them where they want to go, which is scarce finance. They can be relied on never to argue for more than six months for loose money and low interest rates.
I read the Economist regularly, and I do have to say that they have paid lip service to fighting deflation. The fear of deflation was the flavor of the year for the first few years of the decade, with Japan having shown everyone that it can actually matter. But at the first sign of rapidly rising asset prices, they were ready to declare a bubble and run for the cover of tight money. And even in the middle of the deflation scare, the Economist was not whole-hearted about supporting easy money, and seemed terribly embarrassed to have to consider Keynesian issues like liquidity traps. The idea that plain old demand side stimulation could have a positive effect with no downside seemed like a pill too bitter to swallow. Nor did they ever quite acknowledge the notion that deflation’s mechanistic effects happen even if it is “good”, i.e. supply side, deflation. (Mechanistic effects involve an excess of savings over investment, and a tendency by consumers to delay purchases in hopes of getting a lower price by waiting). Needless to say they didn’t get close to the next implication, that “bad” deflation (demand side) was the real concern, for non-mechanistic reasons.
In a publication supposedly enamored of “crunchiness”, such waffling should be greeted with hoots of derision. The truth is that they prefer it (some ill-defined mix of clarity with a preference for taking sides when a dispute is on) only when it lends some apparent credibility to an otherwise offensive (rightist) position, like Margaret Thatcher’s poll tax. The whole ethos of the economics profession feeds on this same tension, claiming, for example, to see through hypocritical appeals to cooperative behavior or concern for the poor to recognize cynical political motives. When all the while it is the supposedly more realistic view that is being consciously chosen for its service to the well-being of the affluent. If a theory like the benefits of free trade (to which I subscribe) makes use of fuzzy assumptions and glosses over inconvenient facts, it is nevertheless billed as crunchy for being more hard-headed and realistic than typical quasi-patriotic opposing views. But an inconvenient truth, like that of Keynesian macroeconomics, is inspected carefully for inconsistencies, vagueness, and other potential points of vulnerability.
The Economist knows, but will not admit plainly, that Keynesian analysis makes sense, at least in the short run when demand is weak. They simply will not entertain the possibility that long run equilibria may be permanently stunted by tight money, nor by deflationary sagging of Aggregate Demand. And they are as obviously put off by the possibility that there really is a savings glut in the world, as Bernanke would have it, amounting to a rerun of Keynes’ paradox of thrift.
The current state of the world does not yet call for tight money. But Wall Street, and the writers who are close to it, see it otherwise. The yield curve is nearly flat in America, yet the markets predict (hope?) that the Fed will continue to raise interest rates. Europe is still suffering from the drag exerted by the ECB wanting to prove its tight-money credentials in the early years of the Euro. Japan’s economy is picking up, but hardly stressing its capacity.
The price of commodities is the main argument that inflation is the current threat. A rather unorthodox perspective on that could shed light on the overall methodology implied: consider a slightly different version of the ECB policy over the last 5 years. Although oil prices might be higher if the ECB had loosened interest rates, as I would argue they should have, it is also possible that oil prices would have risen sooner, and that by causing refining capacity to have been expanded, this might have caused a net result for today of lower oil prices than the ones we are seeing.
Based on similar considerations I will predict, though with only moderate confidence, that commodities (including oil) will rise no more than 10% in price in the next two years (in yen and Euros – sorry, but I still expect the dollar to fall). They are likely to go into backstop mode before rising much more, when “expensive” sources come on line in large enough quantities to prevent further rises. For oil, these backstops range through gasohol, nuclear, wind and solar power, to difficult sources like tar sands and technological substitutes like cogeneration and hybrid and hydrogen engines. For minerals they are more likely to involve new sites, and old, “played out,” sources.
The more important question is whether anyone notices that this represents a pattern with bottlenecks: that when price rises fast it is likely to go above the long run equilibrium, but that the real clearing of the bottleneck requires demand pressure to be sustained in the face of the resulting inflation. If the economy is cooled in response to a jump in commodity prices, there will be a self-fulfilling result of low inflation, but no one will notice that the inflation would have been cleared out anyway, by expanded supply in the medium term.
I find myself wondering regularly how much of the supposed success against inflation of the Volcker years was really a confluence of trade competition, labor-saving technology, and a macroeconomic slowdown that need not have been anywhere near as severe if the Fed had waited for the other two forces to clear the labor bottleneck. Clearly money needed to be tightened. But sustaining a slower pace of growth would have been a better target than forcing inflation to slam down quickly.
Most awkwardly of all, it probably would have allowed Jimmy Carter to be re-elected, instead of “history’s most over-rated president” Ronald Reagan (in the recent words of Thomas Friedman). But there were not voices around who had the credibility of having resisted the excesses of Keynesian enthusiasm, while still having the perspective to factor in the sizes of the tsunamis that were arriving. How ironic that Reagan may have been elected due not only to the convenient fallacy of supply-side economics (which voters were properly skeptical of) but also possibly the less palatable fallacy of strict monetarism.
But then, for the Wall Street Journal and the Economist, strict monetarism was never unpleasant. Because when capital is scarce (as Robert Aliber used to point out), capitalists make more money.
What this episode revealed is that these two conservative, business-oriented publications are mainly interested in keeping finance scarce. They may find lots of arguments convenient along the way because these arguments take them where they want to go, which is scarce finance. They can be relied on never to argue for more than six months for loose money and low interest rates.
I read the Economist regularly, and I do have to say that they have paid lip service to fighting deflation. The fear of deflation was the flavor of the year for the first few years of the decade, with Japan having shown everyone that it can actually matter. But at the first sign of rapidly rising asset prices, they were ready to declare a bubble and run for the cover of tight money. And even in the middle of the deflation scare, the Economist was not whole-hearted about supporting easy money, and seemed terribly embarrassed to have to consider Keynesian issues like liquidity traps. The idea that plain old demand side stimulation could have a positive effect with no downside seemed like a pill too bitter to swallow. Nor did they ever quite acknowledge the notion that deflation’s mechanistic effects happen even if it is “good”, i.e. supply side, deflation. (Mechanistic effects involve an excess of savings over investment, and a tendency by consumers to delay purchases in hopes of getting a lower price by waiting). Needless to say they didn’t get close to the next implication, that “bad” deflation (demand side) was the real concern, for non-mechanistic reasons.
In a publication supposedly enamored of “crunchiness”, such waffling should be greeted with hoots of derision. The truth is that they prefer it (some ill-defined mix of clarity with a preference for taking sides when a dispute is on) only when it lends some apparent credibility to an otherwise offensive (rightist) position, like Margaret Thatcher’s poll tax. The whole ethos of the economics profession feeds on this same tension, claiming, for example, to see through hypocritical appeals to cooperative behavior or concern for the poor to recognize cynical political motives. When all the while it is the supposedly more realistic view that is being consciously chosen for its service to the well-being of the affluent. If a theory like the benefits of free trade (to which I subscribe) makes use of fuzzy assumptions and glosses over inconvenient facts, it is nevertheless billed as crunchy for being more hard-headed and realistic than typical quasi-patriotic opposing views. But an inconvenient truth, like that of Keynesian macroeconomics, is inspected carefully for inconsistencies, vagueness, and other potential points of vulnerability.
The Economist knows, but will not admit plainly, that Keynesian analysis makes sense, at least in the short run when demand is weak. They simply will not entertain the possibility that long run equilibria may be permanently stunted by tight money, nor by deflationary sagging of Aggregate Demand. And they are as obviously put off by the possibility that there really is a savings glut in the world, as Bernanke would have it, amounting to a rerun of Keynes’ paradox of thrift.
The current state of the world does not yet call for tight money. But Wall Street, and the writers who are close to it, see it otherwise. The yield curve is nearly flat in America, yet the markets predict (hope?) that the Fed will continue to raise interest rates. Europe is still suffering from the drag exerted by the ECB wanting to prove its tight-money credentials in the early years of the Euro. Japan’s economy is picking up, but hardly stressing its capacity.
The price of commodities is the main argument that inflation is the current threat. A rather unorthodox perspective on that could shed light on the overall methodology implied: consider a slightly different version of the ECB policy over the last 5 years. Although oil prices might be higher if the ECB had loosened interest rates, as I would argue they should have, it is also possible that oil prices would have risen sooner, and that by causing refining capacity to have been expanded, this might have caused a net result for today of lower oil prices than the ones we are seeing.
Based on similar considerations I will predict, though with only moderate confidence, that commodities (including oil) will rise no more than 10% in price in the next two years (in yen and Euros – sorry, but I still expect the dollar to fall). They are likely to go into backstop mode before rising much more, when “expensive” sources come on line in large enough quantities to prevent further rises. For oil, these backstops range through gasohol, nuclear, wind and solar power, to difficult sources like tar sands and technological substitutes like cogeneration and hybrid and hydrogen engines. For minerals they are more likely to involve new sites, and old, “played out,” sources.
The more important question is whether anyone notices that this represents a pattern with bottlenecks: that when price rises fast it is likely to go above the long run equilibrium, but that the real clearing of the bottleneck requires demand pressure to be sustained in the face of the resulting inflation. If the economy is cooled in response to a jump in commodity prices, there will be a self-fulfilling result of low inflation, but no one will notice that the inflation would have been cleared out anyway, by expanded supply in the medium term.
I find myself wondering regularly how much of the supposed success against inflation of the Volcker years was really a confluence of trade competition, labor-saving technology, and a macroeconomic slowdown that need not have been anywhere near as severe if the Fed had waited for the other two forces to clear the labor bottleneck. Clearly money needed to be tightened. But sustaining a slower pace of growth would have been a better target than forcing inflation to slam down quickly.
Most awkwardly of all, it probably would have allowed Jimmy Carter to be re-elected, instead of “history’s most over-rated president” Ronald Reagan (in the recent words of Thomas Friedman). But there were not voices around who had the credibility of having resisted the excesses of Keynesian enthusiasm, while still having the perspective to factor in the sizes of the tsunamis that were arriving. How ironic that Reagan may have been elected due not only to the convenient fallacy of supply-side economics (which voters were properly skeptical of) but also possibly the less palatable fallacy of strict monetarism.
But then, for the Wall Street Journal and the Economist, strict monetarism was never unpleasant. Because when capital is scarce (as Robert Aliber used to point out), capitalists make more money.