Oil prices and inflation

The price of world commodities is governed by a number of factors. The most obvious factor is the law of supply and demand. An average American manages to get through 25 barrels of oil a year. South Korea, which has a highly developed economy, consumes seventeen barrels of oil per person per year. China at present consumes three barrels of oil per inhabitant each year; in 2006 it consumes only one and a half barrels per person. India consumed four fifths of a barrel of oil a year. Clearly as demand increases with increasing prosperity in China and India, vast nations, so we are likely to expect great upward pressure on oil over the next ten years unless the oil producers can find and bring to market an additional 50% of the oil that they sell each year today.

You can figure out the likely price of oil in ten years time with by assuming different rates of increasing developing world consumption of it, factoring in decreasing developed world consumption and estimating production rates of oil. Taking the most reasonable and less controversial assumptions in all cases would bring you to an oil price in ten years time that is double the price of oil today in real terms, allowing for inflation.

One reaction to an increasing price of oil may be to print more money – quantative easing, although quite what is eased by printing money is beyond me. This has been suggested recently by the US Federal reserve, as a way of coping with oil prices. It is merely a sticking plaster solution when drastic surgery is required. Printing more money or issuing more credits to enable things to be bought for which there is no demand may fool some of the people some of the time but it will not fool everyone; sooner or letter the penny drops in the minds of the public who will regard the currency so “eased” as increasingly less valuable. This is what we hitherto called inflation.

It seems that inflation is already beginning to affect currencies subject to quantative easing. In the United Kingdom inflation is at 4.4% per annum according to the latest figures and this is not driven by wage increases – in fact real wages have fallen in the past twelve months, but by commodity and raw material prices, including those of food. The current rate of inflation in the USA is 2.11%. The Euro zone inflation rate is 2.4%. Their economies are not materially different from the British economies.

Inflation must be affecting the oil price (and the price of other commodities)  so it seems that one of the costs of quantative easing introduced to “save” the banking system in the West is to create higher oil prices in a world where supply is finite and demand increasing.

Many economists are concerned that increasing price of oil will slow down economies as businesses (particularly those in production) will find it hard to raise their finished goods prices to cover the increased energy costs because consumers will not have the money to pay for the goods at higher prices. I am not so sure that things will work out quite in this way. In any event there are plenty of efficiencies that could be made in the use of all fossil fuels including oil, which will keep demand lower if we are prepared to pay the price for such efficiencies.

The price is our perceived comfort in doing things the way we have always done things – it is the same “business as usual” scenario beloved of climate change analysts. If we followed Spain’s example and lowered speed limits, we might find it less convenient but it is unlikely to cost us significantly, when taking into account the fuel savings.

I think the same applies to the increasing food prices. We will all have to learn to eat less, and in the case of most people living in developed countries that will be a healthier option.

There are always those that do things in excess, obscenely so in some cases. Moderation in fuel and food will be no bad thing.

One Response

  1. […] Oil prices and inflation « Robert Kyriakides’s Weblog […]

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