Working Papers

The Raisins of Mild Inconvenience

Gerard Baker on the Great Depression that wasn’t:

I don’t know about you but I feel a bit cheated. There we all were, led to believe by so many commentators that the sub-prime crisis was going to force the United States into a new era of dust bowls and breadlines, a slump that would call into question the very functioning of the capitalist system in the world’s largest economy. Carried away on the surging wave of their own economically dubious verbosity, the pundits even speculated that this unavoidable calamity might presage some 1930s-style global political cataclysm to match.

Well, it’s early days, to be fair, but so far the Great Depression 2008 is shaping up to be a Great Disappointment. Not so much The Grapes of Wrath as Raisins of Mild Inconvenience.


posted on 07 May 2008 by skirchner in Economics, Financial Markets

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All these pronouncements that the recession is over before its even begun seem a tad premature.  As the Baker says, house prices are still falling, and there’s the “troubling possibility that a period now of shrinking demand could feed back into renewed weakness in the financial system, just as it is starting to heal”.

I don’t think there will be a return of confidence in America until Bush is gone.  Hopefully the election will be the circuit breaker.  I think we underestimate what a depressive effect this most incompetent of administrations is having on America.

Posted by .(JavaScript must be enabled to view this email address)  on  05/07  at  09:04 AM

And then of course there is oil.  Another day, another record overnight ($123.80).  The USD has been trading between 0.63 and 0.65 EUR for two months now, but oil is up around $15 in that time.  So there goes the “oil is a US dollar story” line.

God knows what the price of crude will do if the US economy does recover over this summer driving season.

Interestingly the champion of the anti peak oil camp Daniel Yergin seems to have flipped this week.

This is Yergin on March 14th in the WSJ:

Mr. Yergin’s view: Not much that’s fundamental. Today’s high price is “not about the supply and demand of oil, it’s about the supply and demand of dollars,” Mr. Yergin said, citing a “flight to commodities” by investors skittish about the credit-market crunch. That shift is artificially inflating the price of oil as a hedge against inflation and a weak dollar, he said.

“This is the fifth time we’ve run out of oil,” he deadpanned, recounting past ostensible crises in the industry and talking up his company’s big database of global oil information. “With the data, you don’t see a peak.” CERA currently thinks the new ceiling of global oil production is 105 million barrels a day, and that’s only because personnel and equipment shortages are delaying new projects.

Daniel Yergin, May 7th, 2008, WSJ, Some See Oil At $150 a Barrel This Year

“It’s not that the genie is out of the bottle—it’s that 100 genies are out of the bottle,” said Daniel Yergin, chairman of Cambridge Energy Research Associates. Normally known for optimistic forecasts of lowering oil prices, Mr. Yergin’s firm now says the price could rise to $150 a barrel this year.

The world’s diminished spare production capacity remains the strongest single catalyst for high prices, Mr. Yergin says. The world’s safety cushion—the amount of readily available oil that could be pumped in a moment of crisis—is now around two million barrels a day, according to most estimates. That’s just 2.3% of daily demand, and nearly all of the safety cushion is in one country, Saudi Arabia. Everyone else is pretty much pumping all they can, which makes the world vulnerable to political or other shocks

Many in the peak oil world see Yergin as the ultimate contrarian indicator given that his oil price forecasts have been comprehensively wrong for the past decade.

Posted by .(JavaScript must be enabled to view this email address)  on  05/08  at  12:30 AM

Now The Economist is talking peak oil, and I know how you love The Economist.  Another contrarian indicator?

Over the past seven years, according to Citibank, Russia accounted for 80% of the growth in oil production outside the Organisation of the Petroleum Exporting Countries. The increase in its output in the early part of the decade matched the growth in demand from China and India almost barrel for barrel. Yet in April, production fell for the fourth month in a row. It is now over 2% below the peak of 9.9m barrels a day (b/d) reached in October last year. Before that, the growth in Russia’s output had been slowing steadily, suggesting that the drop is not a blip. Leonid Fedun, a vice-president of Lukoil, a local oil firm, says Russia’s production will never top 10m b/d. The discovery that Russia can no longer be relied upon to cater to the world’s ever-increasing appetite for oil is naturally helping to propel prices to record levels.

Now why would these crazy Russians say such things?

Posted by .(JavaScript must be enabled to view this email address)  on  05/08  at  10:30 PM

Maybe the price of oil has something to do with supply & demand. I know that is revolutionary thinking, but…........

Posted by Saildog  on  05/09  at  07:35 AM

Actually I do have a serious question for all you economists out there:

Bearing mind inflation is about the money supply, how does the price of oil impact inflation? If the money supply was not to increase in a country with net oil imports then higher oil prices would imply less money is available for other purposes and the economy would contract? Is that correct?

Or would the oil price inmpact cost such that producers attempted to pass them on? Also, seeing as we are in a net oil importing country, and money is being exported, should the government allow the creation of sufficient money to offset the loss of money offshore? Does the threat of higher interest rates in this scenario make sense?

Posted by Saildog  on  05/09  at  08:42 AM


A rise in the price of oil acts as a negative supply shock. The economy contracts, so the level of output (and income) decreases, and the price level rises (there is inflation). This occurs without any change in the supply of money. An increase in the supply of money would only temporarily boost output (assuming the change in the money supply was not anticipated). In the long-run however, an increase in the money supply would only add to inflation.

A very useful equation (in fact, I think Milton Friedman said it was the economics equivalent of E = mc^2) is the quantity equation:

M.V = P.Y


M = money supply
V = velocity of money (# of transactions for a given quantity of money)
P = price level
Y = real income (real output)

This says that the quantity of money multipled by the number of times that money is spent on average, is equal to nominal GDP (P.Y).

Taking the total differential, the equation becomes:

m + v = p + y

m = % change in money supply
v = % change in velocity
p = % change in the price level
y = % change in real income

For a country that is a net importer of oil, higher oil prices would reduce that country’s terms of trade, holding all else constant, and act as a decrease in the net oil importing country’s income. It is not that ‘less money’ is available for other purposes, as the quantity of money remains unchanged (assuming monetary policy has not changed). 

Moving to your second paragraph, as I’ve mentioned, the increase in the price of oil would act to increase the price level. I assume when you refer to the ‘threat of higher interest rates’, you are referring to the central bank raising its interest rate. In this instance, such a policy only makes sense if the higher price level that results from the increase in the price of oil causes inflationary expectations to increase. The reason is that monetary policy cannot affect the price of oil; by raising interest rates, a central bank would be forcing other prices down in response to an exogenous, one time shock. If inflationary expectations don’t change, the rise in the oil price raises the price level permanently, but only causes a temporary rise in inflation.

With regard to terminology, money is not being ‘exported’. The quantity of money remains unchanged, absent monetary policy changes. When a country purchases imports, it does not ‘export’ money.

Another useful equation is the balance of payments balance:

CAB + NCI = 0


CAB is the current account balance, consisting of exports, less imports, less income owing to foreigners. NCI is the balance on the capital and financial account, which reflects the difference between domestic investment and domestic savings.

The significance of this equation (CAB + NCI =0 = BOPB) is that a country’s supply of, and demand for, foreign exchange must equal. Supply of foreign exchange consists of EX + NCI, while demand for foreign exchange consists of IM + NIP. Such internationa transactions require no changes in the quantity of money available domestically. Changes in EX, IM, NIP and NCI all result in changes in the nominal exchange rate, assuming it is free to float.

Posted by .(JavaScript must be enabled to view this email address)  on  05/09  at  09:57 AM

Nicely put Greg.

Posted by skirchner  on  05/10  at  03:21 AM

I’m no fan of Conan O’Brien, but this is pretty funny…

I don’t know if you’re aware of this. We just passed a big milestone yesterday. True story. Yesterday was the five-year anniversary of President Bush’s speech in front of the “Mission Accomplished” banner. Yeah, to celebrate, today, President Bush gave a speech in front of a banner that said “Economic Recession Over.” — Conan O’Brien

Posted by .(JavaScript must be enabled to view this email address)  on  05/10  at  11:23 AM

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