Monday, February 7, 2011

Krugman Keeps on Backing into Reality

Paul Krugman today argues that Yves Smith is wrong in her belief that it is speculation that is driving commodity prices. Krugman says it just isn't so:

Many people on the “speculators did it” side like to point to financial data, especially large purchases of futures by various players. But food is a physical commodity, and plays in the financial markets can only move the price to the extent that they affect physical flows and stocks.

Here’s my exotic model of the market for a physical commodity:

OK, how can speculation affect this picture? The answer is, it has to work through accumulation of inventories — physical inventories. If high futures prices induce increased storage, this reduces the quantity available to consumers, and it can raise the price. And you can, in fact, argue that something like this has been happening for cotton and copper, where there are apparently large and growing inventories.

But for food, it’s just not happening: stocks are low and falling.

My experience in these debates is that the response consists of a blizzard of statistics about the size of forward positions, etc.. But remember, every purchase of a futures contract is also a sale — there’s someone on the other side. And neither the purchase nor the sale changes the physical quantity of the commodity available to the market.

So if and when I see signs that speculation is really driving up prices, I’ll say so. But the signature just isn’t there right now.
Krugman is correct here, he has backed into reality, again. Only for a short-time though. He will further argue that it is the supply side problems and demand from BRICS that is resulting in the climb in commodity prices. This is partly true, but he ignores the increased Fed money factor that is also fueling price inflation at the commodity level. He doesn't explain why he ignores this factor. He just does, even though it is clear Bernanke money is fueling price climbs in other sectors of the economy, such as the stock market.

1 comment:

  1. It's a shame he can't make the leap to viewing money as subject to the same laws of supply and demand as "physical commodities"; he could use the exact same model he has there to explain the price inflation as a result of decreased demand for paper money.