The Economist: Oil Problem

A weaker dollar does mean that Americans face higher prices at the pump. But the story of rising commodity prices, and rising prices for oil in particular, is about more than central bank action. The new issue of The Economist addresses the recent jump in crude:

According to Goldman Sachs, world demand in the first eight months of the year was 2.7m bpd higher than in the same period in 2009. On October 6th WTI rose above $83 a barrel, a five-month high, and retreated only slightly after reports of a surprising increase in American stockpiles.

In 2011 the fundamentals of supply and demand are likely to exert more upward pressure on prices. Francisco Blanch of Bank of America Merrill Lynch reckons that global demand is set to expand by 1.4m bpd as growth in developing countries offsets a decline in demand from sluggish rich countries. As a result he expects prices to hit $100 next year and to average $85 a barrel over the course of 2011.

The thing to understand about prices for many commodities, and for oil especially, is that they’ve been held down over the last two years by slow growth in emerging markets and enormous slack in the rich world. The impact of monetary easing on the level of the dollar and therefore on the price Americans pay for oil is secondary to the impact of global growth (some of which will be do to reflationary efforts by central banks) on fundamentals.

This doesn’t mean that the Fed won’t come in for criticism if oil prices rise, particularly when those increases begin pushing up headline inflation numbers. But I think it’s a mistake to look at this dynamic as problematic for central banks. On the contrary, it means they’ve been doing a better job, pushing output closer to its potential level and fighting off deflationary pressures. It took serious economic weakness to keep prices down, and if the cost of an end to that weakness is higher prices, well, that’s a cost worth bearing.

Economist