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Paul Krugman Critiques Guillermo Calvo on Commodity Prices

The fact that somebody has bought an oil futures contract means that somebody else has sold one--hence no effect on demand without real storage. Paul Krugman critiques Guillermo Calvo and others:

Calvo on commodities - Paul Krugman - Op-Ed Columnist - New York Times Blog: When I think about speculation, I always start from Paul Samuelson’s classic analysis in terms of intertemporal price equilibrium (a 1957 paper — and not available, as far as I can tell, online. Why isn’t Weltwirtschaftliches Archiv on JSTOR?). Speculation can affect spot prices because it takes physical stuff off the market. Argue, if you like, that the inventory data are unreliable, or that stuff is being held in the ground [or in gas tanks]; but don’t tell me that physical quantities are irrelevant.

Second, Calvo argues that inflation risks stem mainly from excess liquidity. He’s in good company there, but... I don’t trust hydraulic metaphors for monetary economics. And we are in a world where central banks target interest rates.... On a happier note, it’s great to see top-flight economists weighing in on the crucial issues of the day. It’s kind of like the Asian financial crisis of 1997-1998, which was bad for the world but a sort of golden age for policy-relevant theory.

Update: Some correspondents have asked me what I think about the Congressional testimony of Michael Masters, who told a Senate subcommittee that “index speculators” — institutions that buy commodity futures as an investment — are responsible for the price surge. The short answer is that I think his testimony is just stupid. Here’s what he says:

Index Speculators’ trading strategies amount to virtual hoarding via the commodities futures markets. Institutional Investors are buying up essential items that exist in limited quantities for the sole purpose of reaping speculative profits.

That quote pretty much epitomizes what’s wrong with a lot of what people say about speculation. Buying a futures contract for oil does not reduce the quantity of oil available for consumption; there’s no such thing as “virtual hoarding”. And Masters really is confused about the difference between paper contracts and physical stuff. He compares the growth in the futures market with increased consumption from China, and says

The increase in demand from Index Speculators is almost equal to the increase in demand from China!

Again, the fact that someone bought a futures contract (which means that someone else sold one) doesn’t reduce the amount of oil available to consume. I’m willing to listen to serious arguments about how speculation might be affecting the price, but you do see a lot of dumb stuff. And this is really, really dumb.

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