Duncan’s Economic Blog

Inflation or Deflation… or Both?

Posted in Uncategorized by duncanseconomicblog on May 29, 2009

As Samuel Brittan notes in today’s FT economists and financial market participants are currently divided over whether the greater threat is inflation or deflation.

As I’ve made pretty clear over the past few months I’ve been more concerned about deflation.

But Graham Turner’s excellent book is making me seriously consider a third option: deflation & inflation .

Now this seems as first sight preposterous – is deflation is falling prices and inflation is rising prices, how can we possibly experience both at once?

The answer can be found in Peak Oil.

Peak Oil is simply defined in Wikipedia as:

Peak oil is the point in time when the maximum rate of global petroleum extraction is reached, after which the rate of production enters terminal decline. The concept is based on the observed production rates of individual oil wells, and the combined production rate of a field of related oil wells. The aggregate production rate from an oil field over time usually grows exponentially until the rate peaks and then declines—sometimes rapidly—until the field is depleted. This concept is derived from the Hubbert curve, and has been shown to be applicable to the sum of a nation’s domestic production rate, and is similarly applied to the global rate of petroleum production. Peak oil is often confused with oil depletion; peak oil is the point of maximum production while depletion refers to a period of falling reserves and supply.

Andreas too has been showing an interest in this issue. The Oil Drum is the leading website on this issue.

This might all seem a little arcane and distant but by many people’s estimate we are at or very near to the Peak in terms of oil production. Once the Peak is reached, so the theory runs, oil prices will soar. The current price of around $65 a barrel will appear ludicrously cheap and the high price of $147 hit last year would easily be exceeded.

There is a direct link between oil prices and food prices (note how the two moved together last year) driven by the use of bio-fuels. As oil prices become higher, farmers are likely to shift crops towards bio-fuel production driving up food prices.

Rapidly rising food and fuel prices act as a tax on the world economy, as the price elasticity is low – people need to travel and eat. If anything this would reinforce the deflationary trend on manufactured goods and services as customers had even less free cash to spend.

We would in effect experience the worst of both deflation and inflation. Falling goods and services prices driving down corporate profits and leading to increasing unemployment but rising fuel and food prices which would hit the poorest the hardest.

I don’t know enough about geology to comment on how accurate Peak Oil theories are. But I can see an awful lot of clever people citing what seems to be compelling evidence. If this is true it is very worrying. Indeed I would go as far as to suggest it is a more immediate threat to the world than climate change.

At the very least Governments need to look into this issue seriously and, if it turns out to be correct, than we need a massive shift to low carbon technology even quicker than I have previously feared.


6 Responses

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  1. yorksranter said, on May 29, 2009 at 12:01 pm

    May I suggest you also read POD as well as TOD? And also Robert Rapier’s blog? For a solution-focused take on the problem.

    • duncanseconomicblog said, on May 29, 2009 at 2:37 pm

      Thanks for those. I’ll have a look.

  2. CS Clark said, on May 29, 2009 at 8:14 pm

    ‘There is a direct link between oil prices and food prices (note how the two moved together last year) driven by the use of bio-fuels. ‘

    Well yes, there is the biofuel link, but also the use of oil in modern agriculture, both in the obvious need for tractor fuel and transport costs and the less obvious use in petrochemical fertilisers. The latter means that even if we had portable fusion generators tomorrow, a rise in oil prices might still result in rising food prices.

  3. tory boys never grow up said, on May 30, 2009 at 10:06 am

    One of the factors which was said to aid the slow recovery from the Great Depression, in the absence of any proper Govt. stimulus until rearmament and WW2, was the impact of price deflation which eventually made those in employment feel better off and start spending. Given that such a luxury may not be available this time then good old Keynesian reflation would seem to be the only obvious answer. Although, of course if such reflation is green and reduces the demand for fossil fuels all the better.

    Something also needs to be done about the oil market (which I think you are right in identifying as the source of instability in food and other commodity markets) – which given its demonstrable volatility, has clearly been the plaything of speculators rather than an effciient maket giving clear signals to suppliers and consumers. Controls over hedge funds, the banks which provide them with leverage, and ill conceived markets in derivatives might be a good start. It is worth noting that although we in the West have to date been able to handle this price volatility – it really has become a matter of life and death for many in the 3rd world, particularly in those countries which are not energy rich.

  4. tory boys never grow up said, on May 30, 2009 at 10:10 am

    Also worth noting that many of those with most to gain from oil price volatility are not above putting out varying theories to aid the price manipulation that they aim to achieve. It wasn’t too long ago that some were forecasting oil at $10-20 per barrel.

  5. […] recently found. It’s someone’s, called Duncan, economic blog what I like was especially this post and this […]

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