One of the features of the world economy right now is the fall in commodity and oil prices. This is something which has been developing since May in commodity markets although the overall peak in commodity prices was back in April 2011 when the Commodity Research Bureau index topped out just over 580. The pattern for the oil price is very similar with the peak of 2011 being followed by a drift lower which has become a sustained fall since late June. There are a lot of implications from this but I wish to state at the outset that the media headlines which scream deflation in response to this are as much “inflation-nutters” in my view as those who continually predict hyper-inflation. We live in a world where the chances of both remain low even though they both have risen. But the deflationistas have blinkers on as they repeat the phrase “there is no alternative” and sing along to the lyrics from REM that I quoted yesterday.
It’s the end of the world as we know it
It’s the end of the world as we know it
What is deflation?
It is a fall in aggregate demand in an economy. In its worse case it is associated with falling prices or outright disinflation and also falling wages as everything hits a downwards spiral. This can happen as the Euro area has demonstrated with its policy disaster that is Greece and there are plainly deflationary issues for Italy and France. But it can also happen without falling prices,they do not have to come together. After all I discussed a case only yesterday in Russia where there is deflationary pressure from higher interest-rates and a lower oil price plus plenty of inflation.
What is reflation?
This is simply an increase in aggregate demand and many countries are seeing this right now as lower oil and commodity prices means that for a given income they have more to spend on other things. Also as lower prices lead to lower inflation – even the UK only has an official consumer inflation rate of 1.2% now – then some of the pressure on real wages will be relieved. These sort of effects can be very powerful.
Unfortunately the economic literature (econometrics) on this subject has mostly confused itself. A fundamental problem happens measuring anything in economics because nothing happens in isolation. But whilst improved energy efficiency means that oil price effects are not what they were in the 1970s they have picked up since the middle of the last decade. And yes if you do read the literature it told you that the impact had pretty much disappeared just as it returned!Oh well. So I remain of the view it is quite a powerful mechanism but cannot outright prove it. Also the credit crunch has raised the impact of it as we observe yet another impact of it. For the UK this shift is added to be the fact that we moved from being an oil exporter to an importer over the same period.
There are also shifts of income and wealth
Changes in oil and commodity prices have a redistributive effect. Perhaps the simplest to think of is the gains to the Middle East from oil price rises and right now they way that many there must be grinding their teeth as it falls. Also there is the case of the South China Territories ( Australia and in particular western Australia) which boomed on the back of supplying ever more commodities to China at ever higher prices. Well until recently anyway.
On the other side of the coin commodity buyers experience relative drains on their income and wealth to buy these goods but right now are gaining as prices fall and their money goes further.
Right now there are issues with this for my subject of yesterday Russia which is seeing shifts of both income and wealth away from it especially for the period which the oil price has been below its estimated cost of production of US $90 per barrel. Many will be wondering if the game of realpolitik is at play here.
The oil price
The price of a barrel of Brent Crude Oil has fallen another 2% to US $83 today after Saudi Arabia cut prices to the United States. This means that a fall of 6% in July was followed by a fall of 2% in August, 8% in September and 12% in October. Putting it another way it has fallen by 22% on a year ago. So this is a better phase for the Harvard Energy Survey I reviewed back on the 20th of July 2012.
Contrary to what most people believe, oil supply capacity is growing worldwide at such an unprecedented level that it might outpace consumption. This could lead to a glut of overproduction and a steep dip in oil prices.
It took a couple of years but maybe at least for now they are being proved right. Of course “peak oil” will have better days than these but for now whilst there are also redistributive effects this is good for the world economy.
One impact will be on users of fuel as for example diesel prices at the pump in the UK are 9 pence per litre cheaper than a year ago and petrol prices are 6 pence lower. As a diesel driver may I welcome the split! Also @MarcoMNYC pointed this out on twitter earlier.
based on 2013 gasoline consumption..a move from 3.5 to 2.75 a gallon gives back 100.87 Bn USD.
The headliner in this area has been the price of iron ore which due to the slow down in China has been falling in 2014. According to Bloomberg the beat goes on.
Ore with 62 percent content delivered to Qingdao fell 1.2 percent to $78.63 a dry metric ton yesterday, the lowest since Sept. 30, according to Metal Bulletin Ltd.
Iron ore in Qingdao tracked by Metal Bulletin is 42 percent lower this year.
If we move onto more general commodity prices then it thinks this.
That’s a steeper decline than posted by the Bloomberg Commodities Index (BCOM) of 22 raw materials from gold to crude oil, which dropped 7 percent in 2014.
Actually I think that Bloomberg has missed a trick with its own index as the fall since the beginning of May or the new disinflationary phase has been just under 16%.
Oh and whilst overall prices are lower not all are. Food prices rallied by so much before the disinflationary phase started that they are still 8% higher on the year.
What about Japan and Abenomics?
Here we have a “Houston we have a problem” moment. Japan is using a currency depreciation to stoke inflation and to supposedly thereby reflate as well as inflate its economy. However right now its industries would be benefiting from lower import costs as their competitors are. But Abenomics is denying them some of the gains which in price-competitive industries might be fatal.
There is much to consider from the current phase of lower commodity and oil prices. Whilst they may be a response to the economic disappointments of 2014 we should not ignore the fact that they offer gains in 2015 and 2016 should they be sustained. A Type of self-correcting mechanism if you like or it will be if policy-makers do not interfere. Such a theme provokes a wry smile on a day where the European Commission has cut the economic growth forecasts for Europe. Timing is not their forte. But my rebuttal to the deflation mania infecting the media is that falls in inflation can be welcome and are welcomed by many who are hard-pressed in these times. Just as they panic a self-correcting mechanism looks to be in play.
However not everyone benefits as there are losers such as oil producers and commodity producers. I mentioned earlier that the oil producers of the Middle East and commodity miners in Australia will be losers as I guess will Canada. But for much of the world it will be welcome. Can it go on forever? Well maybe not as I guess more and more oil production is becoming uneconomic especially the frackers. If I did not already think this the regular denials would do the job!
Meanwhile in the background it would appear that there are genuine advances in photo-voltaic or solar power such that it is not inconceivable it will match conventional energy costs. Good job the UK paid so much for its new nuclear power station…….