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My friend and PhD candidate in economics, McD, left the following comment on my post Petrol Price in Gold Terms, where I point out the reasonably constant ratio of the two commodities since 2002:
With regard to your post here… I’ve often seen this comparison made and don’t find it nearly as profound as is made out. In fact, I’d go so far as to say that you have the causation roughly backward. Energy is critical input for all mining activity. Why then wouldn’t you expect gold to exhibit some kind of long-term mean relationship with oil?
You could make the same comparison using a number of commodities and arrive at more-or-less the same result. The point is that energy is a crucial input for all of them and ultimately determines supply prices. See here.
My answer: I do expect commodities to exhibit a long-term mean relationship with oil. What I do not expect, however, is that the exchange value of paper monies (like Rands and US dollars) to commodities will be constant.
So to be clear (which I was in the first post, but to make the point again), my argument is that it is the exchange ratio of the rand to both gold and oil that is going down because paper monies are being debased, and that this is why the price of both gold, oil, wheat, soybeans, etc. have all increased since 1971 in paper money terms, or why they did not fall as far as they otherwise would have in the absence of an increase of paper money supply.
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[...] adding a bit to Chris’ post, it’s McD who has ”the causation roughly backward.” It’s not input [...]
Okay, I have left some comments on Russell’s longer post, but quickly:
a) No, your specific point was that the increase in SA petrol prices over the last ten years is entirely due to the actions of the South African Reserve Bank and a weakening of the Rand. (You were quite clear about this.) I didn’t want to push the issue, but this isn’t even true. First, the Rand has strengthened from 12:1 against the dollar (which oil is priced in) since the beginning of 2002 to about 8:1… I.e. an appreciation of forty percent! Second, the SARB has had relatively little impact on the price that local consumers pay for petrol over this time period. By far the biggest factor in determining what South Africans pay at the pump is the international oil price, which the SARB is powerless to dictate. Here is a graph showing the extent to which SA petrol prices are cointegrated with international crude prices.
b) Regardless, let’s consider your meta argument about paper monies generally versus gold. I agree entirely that the nominal price increase in commodities is primarily a monetary phenomenon. (Who would disagree?) Indeed, my post — which was really a follow-up to a more substantial one — was aimed at showing that the gold-oil relationship that you and many others highlight is not unique. Nor is it necessarily reflective of any special qualities that gold may or may not possess. It’s quite striking that one never sees the additional graphs that I provided (i.e. copper, fertilizer, etc in terms of oil)… It’s only ever in terms of gold. Why? I suspect that this betrays an ideological bias, but it is also likely a failure to appreciate the common factors that cause commodities to share the same general price movements. (Remember, this isn’t just about whether the average values change over time, but the fact that they actually co-move in real time… Again, this graph makes the latter point quite clear.)
c) Yes, inflation has eroded the paper money value of these commodities since 1971. (As per your comments on my blog, we both agree that real values actually declined over the majority of this period.) Tell me though, what has happened to real incomes over this period? Spoiler: Here is a graph showing employee compensations versus CPI in the US since 1971.
Cheers pal.
No, as regular readers of this site will know, eg. see here, here, here, here, here, my specific point is that the SARB’s Rand debasement policy of inflating the Rand money supply by 250% since 2002, is why the exchange value of the Rand to petrol has gone down by roughly 250%. Of course the Rand is not the ONLY reason for a higher petrol price, but since then it is the most important, for various reasons.
There is a supply/demand for petrol, and supply/demand for the Rand, the interaction of the four that result in a final price (plus taxes).
Seriously, Mcd, you are lost. I never said the gold/oil relationship is unique. I have written before about how King Steer Burgers have maintained a constant exchange ratio to the petrol price since 2002, while the Rand has not. See here. My point is that the factors that cause commodities to share the same general money price movements are mostly currency related.
On your point c, you’re the one bringing real prices into the debate. My point is that money prices (i.e. nominal prices) are rising owing to currency debasement. If we can agree on this (which we seem to), then I don’t see where you are trying to go with this, other than to try and downplay the impact that centrally planned currency debasement has on individuals in the economy. On this topic we will probably disagree, but this is another debate entirely.
Seriously, Mcd, you are lost.
Please, spare me the sanctimony. Your initial post made a number of direct claims which, as I have pointed out, were highly contingent at best.
You’re the one bringing real prices into the debate.
Um, yes, because any meaningful debate about commodity prices has to focus on real values. Nominal prices are very misleading in of themselves and, frankly, it appears that you are suffering from chronic money illusion.
On that score, there have been a host of real shocks that have contributed to the appreciation of real commodity prices over the last decade. For example, in the oil market these would include: surging demand from emerging economies, stagnating supply from major producers, supply chain shocks due to war and civil unrest (Iraq, Libya), a transition to more expensive sources (tar sands, deep offshore), natural disasters (Hurricane Katrina, Deep Horizon spill), etc etc.
These factors are common to — or have filtered through to — other commodity groups as well. In some cases, they have been exacerbated by things like inane biofuels policy and crop failures due to unprecedented heat waves (former USSR in 2010, the US this year)… Still, at least we can rest assured that anthropogenic climate change is a socialist conspiracy!
So there have been “real shocks” in most commodity markets, that have driven the price of a King Steer burger up 250% in ten years, the FNB average house price index up 251% since 2002, the price of a loaf of brown bread up by 190% since April 2004, price of 2 liters of milk up by 150% since 2002 (despite reduced quality being measured from fresh to long life milk), or the price of margarine up by 350% since 2002.
But I don’t buy it, I maintain the view that currency debasement policies are the main driver of generally rising money prices of commodities. In any case, I think you should take your currency debasement defense someplace else. Actually, I’ve got an idea: Maybe you can come and convince the unemployed people of SA (or even the workers at Marikana) that real wages are really up, and that they should stop protesting and complaining, because they are better off today than they were in 2002.
Cheers.
In any case, I think you should take your currency debasement defense someplace else.
Dissenting opinions will not be tolerated!
Kidding. (Sort of…)
Given the rising levels of acrimony, I’ll try to be constructive and sum up my position with a final comment. The “in-terms-of-gold-price” is simply one relative measure, as is any other depending on your chosen numeraire. As I have constantly tried to emphasise, however, commodities as an asset class share key common characteristics and are driven by the same underlying economic factors. We would consequently expect them to maintain a more-or-less constant parity and, indeed, there is very clear empirical evidence that commodity prices actually move together (in contrast to their relationship with other goods).
If one took your position consistently (i.e. that everything should be priced relative to gold to obtain its “true” value), then you would have to conclude that the cost of nearly all other goods have been plummeting since 2002. Apparel, communication, education, health care, recreation, etc… all falling. Do you believe this?
Far from denying the monetary role in creating (nominal) inflation, I embrace it. (I honestly don’t know a single economist who would deny the link. There’s also an important discussion to be had about velocity in addition to money supply, but that will have wait until another day.) That said, I believe that real factors have come to dominate the price movements of commodities in recent years. For example, the convergence of real and nominal international prices is one piece of evidence in support of my position. At the very least, however, any honest discussion of the issue must include reference to these real drivers.
Later Chine.