Wednesday, September 7, 2011
Gold and Oil
Paul Krugman has a post on gold prices. The basic idea is that if you have Hotelling pricing of gold (price rising at the rate of interest so that it reaches a backstop level at the moment the existing supply is exhausted), a fall in interest rates implies a higher initial price (initial effect) and a flatter price path (subsequent effect). Since interest rates are in fact falling, the expectation is that gold prices should rise in the current period but remain a lousy investment for the future, since the downside potential for interest rates is itself being depleted. One would have to flesh out this model with some parameters to see how well it performs for gold, but what about other commodities? In particular, what about oil?
If Hotelling pricing matters for oil, we should be seeing the same dynamic: price appreciation in the present and the prospect of slower price growth in the future. (Or price declines if interest rates rise.)
Of course, the oil-watching community is not exactly enthusiastic about Hotelling. For one thing, oil royalties are largely under the control of sovereign resource owners, and their motives have almost nothing to do with long run present value rent maximization. Indeed, they may well be motivated primarily by the fragility of their control over these rents: if you are the Saudi royal family, your primary thought about oil pricing is, at what price do I maximize my family’s future control over this rent extraction machine? In addition, uncertainties over stock and production constraints, and unforeseen fluctuations in these factors, defeat any possibility of Hotelling-type calculation. The result is that short run supply and demand are far more important than the pure theory of exhaustible resources would suggest.
And other scarce minerals? Is there any sign of a Hotelling price bump?
My interpretation is that Hotelling prices, like Western Civilization, falls into the category of nice ideas.