Bryan Caplan  

Long-Run Commodity Prices: Essential Readings

Oil: Some Tentative Conclusio... Class Discussion Starter...

In chapter 1 of The Selfish Reason to Have More Kids, I'm going to spend a little time discussing the largely imaginary problem of increasing resource scarcity. I knew the general pattern from folks like Julian Simon, but I wanted to locate the best recent scholarly articles about long-run commodity prices. Since this is a hot topic today, I thought I'd share what I found.

The two best recent articles are probably:

1. Cashin, Paul, and C. John McDermott. 2002. "The Long-Run Behavior of Commodity Prices: Small Trends and Big Variability." IMF Staff Papers 49(2): 175-99.

Main finding: The Economist's index of industrial commodity prices fell by about 1% per year in real terms between 1862 and 1999.

2. Pfaffenzeller, Stephan, Paul Newbold, and Anthony Rayner. 2007. "A Short Note on Updating the Grilli and Yang Commodity Price Index." World Bank Economic Review 21(1): 151-63. (gated, but you can read the abstract)

Main finding: The Grilli-Yang commodity price index, which includes metals, food, and non-food agricultural products, fell by about 0.8% per year in real terms between 1900 and 2003.

Bottom line: Psychologically speaking, it's hard to accept that current commodity price spikes are just a phase. I find it hard to accept myself. But the historical pattern is amazingly strong: In the long-run, commodity prices keep getting cheaper in real terms (and cheaper still compared to real income!).

Further lesson: During the century-plus of secular commodity price decline, there were multiple spikes that probably looked as scary to the people of the past as the current spikes do today. Spikes don't last - but pessimism never dies.

P.S. At lunch today, Tyler tried to convince me that a century-plus of data is pure coincidence. Looking forward, we should ignore the data and believe that arbitrage ensures that commodity prices are a trendless random walk. I think this is crazy - transactions costs and storage costs leave plenty of room for price trends that are not profitable to arbitrage away.

Comments and Sharing

COMMENTS (2 to date)
mr econotarian writes:

The biggest problem is that the prices of commodities may become more dependent on the level of production productivity in countries with lower economic freedom as those with higher levels of economic freedom move into service based economies.

There also is a correlation between higher GDP and environmental laws that also push the majority of prduction into poorer countries with less economic freedom.

Finally, it seems to be easier for an economically unfree country to become a major commodity miner than an agricultural or manufacturing power.

Nathan Smith writes:

How can storage costs be relevant if prices are high NOW and will be lower in the FUTURE?

Well, I guess they're relevant in that arbitrageurs might have hoarded oil in order to cash in on unforeseeable but possible price spikes. But that suggests an asymmetry: If prices FALL unexpectedly, you can transfer oil from the present to the future by storing it, but if prices RISE unexpectedly, you can sell your stocks, but you can't transfer oil from the future to the present. Prices shouldn't fall too far below trend, because arbitrageurs will start hoarding, at least if the dip is deep enough to offset storage costs, transactions costs, and risk aversion. But if prices spike, the only way to deal with it is to invest in exploration and/or switch to energy-efficient technologies/lifestyles, and these processes take much longer and can't be carried out by nimble arbitrageurs. I wonder if the suggested prediction-- commodity price spikes, alternating with long periods of a relatively orderly downward trend-- is borne out by the evidence? It seems to fit the stylized facts of the past 50 years.

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