Wednesday, September 14, 2011

The US Strategic Petroleum Reserve and Buffer Stocks in Post Keynesian Economics

The charge is sometimes made that Keynesians do no consider supply-side factors in their analysis. That charge may have some legitimacy when made against neoclassical synthesis Keynesianism. But anyone who has bothered to study heterodox Keynesianism outside the neoclassical mainstream knows the charge is nonsense.

Post Keynesian economics has long advocated the use of commodity buffer stocks as a policy against supply-side inflation, and a crucial article on this issue remains Nicholas Kaldor’s analysis of stagflation (Kaldor 1976). L. Randall Wray gives us a summary of the Post Keynesian position on buffer stocks:
“To control spot-price inflation (such as oil price shocks), Post Keynesians have advocated using buffer stocks .... Under a buffer stock program the government buys commodities when prices are falling and sells them when prices are rising, thereby helping to stabilise prices. These programs stabilize individual prices; but if some of the commodities are an important part of the consumer basket, buffer stocks would help stabilize the overall price level. For example, stabilizing energy prices would help stabilize the price of most goods, as energy enters directly and indirectly into the production of almost everything.” (Wray 2001: 89).
In the post-WWII world the United States had a program of commodity buffer stocks that ensured price stability and quite low inflation in these years. When these stocks were dismantled in the early years of the Nixon administration, the world experienced the outbreak of supply side inflation, commodity market volatility, and wage-price spirals we know as stagflation (Davidson and Davidson 1996: 166–170).

Curiously, one very important buffer stock that the US still maintains is its Strategic Petroleum Reserve, established in 1975 by the Energy Policy and Conservation Act (EPCA).

In many ways, this reserve is an underused asset, as has been argued by Paul Davidson:
Paul Davidson, “Crude Oil Prices: ‘Market Fundamentals’ or Speculation,” Challenge 51.4 (July/August) 2008.
Davidson carefully analyses the role of speculation on future markets in the disastrous spike in oil prices when oil reached its peak at $138 per barrel in June 2008. That analysis is nicely complemented by Bill Mitchell’s recent post on the role of financial institutions and banks in speculation in food commodity markets (see Bill Mitchell, “We Should Ban Financial Speculation on Food Prices,” Billy Blog, May 27, 2011).

Paul Davidson notes that the spike of 2008 could have been prevented had the US released between 70–100 million barrels of oil:
“…it should be obvious that with the rapid increases in oil prices [viz., in 2008], hedge funds, pension funds, other large financial institutions as well as individual investors have been placing billions into oil commodity markets to hedge against inflation and/or to take increase the value of their portfolios via market price increases. But, as the Keynes concept of user cost suggests, speculators on crude price increases may not only include hedge funds – but may involve oil producing companies and countries who recognize that they must produce sufficient quantities of oil to prevent prices rising so rapidly that the economies of their major markets do not collapse … On the other hand, recognizing that speculation has enhanced the rapid escalation of market price, oil producers do not want to pump enough oil from existing underground capacity to squeeze out speculators and thereby reduce their user costs to zero – or even push user costs into negative territory! … The US government can test this speculation and likely force futures oil prices down, perhaps even well below $100 a barrel, by a strategic use of the world’s largest emergency supply, the US Strategic Petroleum Reserve (SPR). As of May 2008 the SPR held 701 million barrels (96% of capacity). If the United States was to dump say between 70 and 105 million barrels on the future market, it is likely that speculators could lose a significant amount of money, while the U.S. would earn billions of dollars on the sale of oil .... Moreover it would not be the first time that strategic use of the SPR prevented run away crude oil prices. After Desert Storm in 1991, 21 million barrels from the SPR was sold over 45 days. As a result world oil prices [were] … barely disturbed despite the interruption of crude oil supplies from Kuwait and Iraq. Again after Hurricane Katrina shut down U.S. crude production in the Gulf of Mexico (approximately 25% of total U.S. oil production), the release of 11 million barrels from the SPR assured stability in the world’s markets for crude oil.”

Paul Davidson, “Crude Oil Prices: ‘Market Fundamentals’ or Speculation,” Challenge 51.4 (July/August) 2008, pp. 10–11.
A quick review of the instances when the US has released capacity from the Strategic Petroleum Reserve confirms its effectiveness:
(1) 1990–1991: Desert Storm sales of 21 million barrels.

(2) 1996–1997: total non-emergency sales for deficit reduction of 28 million barrels .

(3) 2005: Hurricane Katrina sale of 11 million barrels.

(4) 2011: sale of oil owing to the Arab Spring instability of 30 million barrels.
What is notable is that Clinton even used sales from the Strategic Petroleum Reserve to reduce the US deficit! It should also be noted that Japan has a large Strategic Petroleum Reserve, which in 2010 had 324 million barrels. The European Union countries have significant petroleum reserves too.

So, if the US, EU and Japanese governments took joint action to maintain the price of oil within certain limits, they could break the back of both excess demand-side problems and price rises caused by speculation, perhaps for many years to come. This, along with incentives for increased production and locating untapped oil fields, could provide the necessary energy policy needed for first part of this century, as government and private sector research into alternative energy sources is radically expanded. The challenge would be to establish and use such buffer stocks as growing demand from China and other emerging economies causes much greater need for commodities in future years.

What we need is a new era of energy price stability, and even the re-establishment of other basic commodity buffer stock programs that worked so well from 1945 to the late 1960s. The challenge would be to establish and use such buffer stocks as growing demand from China and other emerging economies causes much greater need for commodities in future years, and the possible severe problems caused by peak oil (for a sceptical view of the peak oil thesis, see here).

As noted by Kaldor (1976: 228-230), an international system of commodity buffer stocks could provide the anchor for a new global reserve currency as well, when the US dollar loses that status:
“I remain convinced … that the most promising line of action for introducing greater stability into the world economy would be to create international buffer stocks for all the main commodities, and to link the finance of these stocks directly to the issue of international currency, such as the S.D.R.s [Special Drawing Rights], which could thus be backed by, and directly convertible into, major commodities comprising foodstuffs, fibres and metals. Assuming these buffer stocks cover a sufficiently wide range of commodities, their very existence could provide a powerful self-regulating mechanism for promoting growth and stability in the world economy.” (Kaldor 1976: 28).
These days you could probably add rare earth metals and oil to Kaldor’s list.

A final point is that on the issue of reforming the international payments system, Post Keynesians and supporters of MMT differ:
Paul Davidson, “Reforming The World’s International Money,” conference paper, New York, November 2008.

Bill Mitchell, “An International Currency? Hopefully Not!,” Billy Blog, November 3, 2009.
Despite these differences, if we add to the commodity buffer stocks the Modern Monetary Theory (MMT) idea of an employer of last resort (ELR) policy (which can be conceived as a kind of buffer stock program too), we have some very sensible policies for the 21st century.

BIBLIOGRAPHY

Davidson, G. and P. Davidson, 1996. Economics for a Civilized Society (2nd edn.), Macmillan, Basingstoke.

Kaldor, N. 1976. “Inflation and Recession in the World Economy,” Economic Journal 86 (December): 703–714.

Wray, L. Randall. 2001. “Money and Inflation,” in R. P. F. Holt and S. Pressman (eds), A New Guide to Post-Keynesian Economics, Routledge, London and New York. 79–91.

16 comments:

  1. I don't see the point.

    "Price stability" seems to have more of a psychological purpose than a resource conservation purpose.

    There already is a mechanism for keeping buffer stocks. It's called prices, which encourages accumulation of inventories during certain period and decumulating them during times of shortages. The only difference is that the highly inelastic demand for commodities like oil means that prices for it can fluctuate rapidly in order to reduce or increase demand when production changes. But those volatile prices are just a reflection of reality, and allow a rapid enough dissemination of information to change producer's and consumer's behaviour.

    Just because it gets us worried and upset, and just because it loses political capital for governments doesn't mean volatile prices are a bad thing. Prices are a reflection of reality and you can't change reality.

    Buffer stocks are simply a relic of WARTIME use, when WARTIME industrial policy and WARTIME price controls determined production and distribution of goods. The authorities had to keep buffer stocks, because it was not prices, wages, and interest rates determining structure and flow of production during the wartime and immediate postar period.

    I don't know why the 1950s are idealized so much in the Western world, given that it was a time of recovery after postwar recession occuring till 1948. Those were times of gradual dismantling of wartime mechanisms, but somehow we instead include that those were good times because of wartime controls still being in place.

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  2. "There already is a mechanism for keeping buffer stocks. It's called prices, which encourages accumulation of inventories during certain period and decumulating them during times of shortages.

    If that were sufficient to prevent wild fluctuation, stagflation would never have happened.

    "Just because it gets us worried and upset, and just because it loses political capital for governments doesn't mean volatile prices are a bad thing. Prices are a reflection of reality and you can't change reality."

    Alot of prices are administered in modern capitalist countries - they have long since lost the "information signalling" role.

    "Buffer stocks are simply a relic of WARTIME use, when WARTIME industrial policy and WARTIME price controls determined production and distribution of goods. "

    On the contrary, buffer stocks have been used throughout history in peacetime - often to eliminate famine and hunger during droughts etc.

    Have you ever read the Biblical story of Joseph in Egypt?

    The "ever-normal granary" form of buffer stock has been instituted in the Western world since at least biblical times, because there is reference to such granaries in the Old Testament. In Genesis, the Egyptians used an ever-normal granary to stabilize their food market during the seven years of high yields and subsequent seven years of famine. Another well-known example of ever-normal granaries is during the Sui dynasty in China (7th century)

    http://en.wikipedia.org/wiki/Buffer_stock_scheme

    "I don't know why the 1950s are idealized so much in the Western world"

    It's not simply the "1950s": 1946-1973 was the Golden Age of Capitalism, superior in terms of real GDP growth, real wage growth, productivity growth, reduced volatility and
    low inflation to what preceded it and followed it.

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  3. Why is volatility a problem anyway?

    Edmund Burke once said in the British Parliament that there is no high price of wheat or low price of wheat, but simply the price of wheat.

    Besides, who makes oil prices so volatile? The people who use oil, who are addicted to oil, who will not give up oil consumption even due to small changes in price, and hence are only forced to demand less under high prices. If that is how badly they want oil, who is anyone to judge this situation to be a problem?

    The general public can not both demand a rigid unchanging flow of resources for their consumption and demand a rigid unchanging price at which they can keep consuming those resources. That oil isn't going to fly right out of the oilwell into the gas tank into their cars all by itself. It costs money to explore and drill it.

    It's stupid to say that public policy should reflect impossible and unmeetable demands, just because the general public wants it. Just because the general public wants neither power cuts or shortages nor high elecriticty bills doesn't mean the government of California can actually provide it.

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  4. "Why is volatility a problem anyway?"

    Isn't that clear from the original post? Volatility in factor input prices is a major source of inflation.

    "The people who use oil, who are addicted to oil, who will not give up oil consumption even due to small changes in price, and hence are only forced to demand less under high prices."

    The 1970s oil shocks were caused by a cartel restricting production, not by excessive demand.

    The 2007-2008 oil spike probably by a large degree of speculation and perhaps even buying in spot markets to drive the price up.

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  5. Thomas Sowell and Walter Williams have lived in extreme poverty, and they often say things to the same effect. Walter Williams himself was recently defending in a column any price rise caused due to speculation, since it forces an early reduction in consumption and rise in production when people anticipate shortages.

    Do these truths become more or less valid based on the economic class of the person who said it? No one argues that The New Deal's philosophy was wrong, because FDR was wealthy inheritor.

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  6. "Edmund Burke once said in the British Parliament that there is no high price of wheat or low price of wheat, but simply the price of wheat."

    A quick search reveals no record of him saying this. In fact, I find numerous passages where he says that certian products in Britain are cheap.

    Assuming he actually said such a thing, it was a preposterous statement from Burke - from a wealthy man who probably never experienced the real burden of paying a high price for wheat in his entire life.

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  7. "Thomas Sowell and Walter Williams have lived in extreme poverty, and they often say things to the same effect."

    I am going to correct my original statement in this new comment above and stress: A quick search reveals no record of Burke saying what you said. In fact, there are numerous passages where he says that certain products in Britain are cheap.

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  8. Do these truths become more or less valid based on the economic class of the person who said it?

    The statement that there is no such thing as a "high price of wheat or low price of wheat, but simply the price of wheat" is absurd.

    Are you really saying that if, say, wheat's price soared by 1000%, well, there is no now "high" price of wheat relative to its earlier price?

    Moreover, since the high and low relative prices of commodities are supposed to communicate information about their scarcity, how on earth can there then be no such thing as high and low prices?

    How is the infomation about scarcity communicated, if not by price rises and falls?

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  9. The notion that price changes reflect relative levels of scarcity and communicate useful information about the state of production is an attractive one. However, wouldn't speculation and the process of accumulation impair or even annihilate this? If people interpret a continuing rise in the price of grain not as a relative disincentive to consume grain but as a signal of further increases in price, then speculation is likely to blow a bubble.

    In my view, the idea of generally equilibrating prices shares some common ground in structure and implication with Say's Law, and it seems to me that it falls by the same arrow, i.e. the distinction which arises between monetary circuits. Under a purely C-M-C configuration, price signals work more in line with the ideal explanation, but once M-C-M' inevitably enters the mix, stability is no longer inherent.

    As such, it seems to me that buffer stocks could go a long way towards offsetting this and moving things back in the direction of meaningful price signals. However, as with all stabilization policy, I have seen it argued (more persuasively by some than others) that this only shuffles the contradictions around, postponing their realization until they've grown more severe.

    Either way, I think the case to be made for buffer stocks - especially in the case of labor, as with the job guarantee - is extremely strong.

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  10. LK, I suppose that when people comment that the price of something is "low" or "high", they generally tend to mean, "This is not what the price is supposed to be."

    To that, one can only respond, "We can only know what is, not what should be."

    Of course, rising and falling prices do indicate something is relatively higher or relatively lower in the consideration demanded than before. No disputes there.

    "The 1970s oil shocks were caused by a cartel restricting production, not by excessive demand.

    The 2007-2008 oil spike probably by a large degree of speculation and perhaps even buying in spot markets to drive the price up."

    Firstly, there are oil producers outside the cartel, and they need not comply with cartel behaviour. So the cartel has some, but not complete control on world oil supply.

    Secondly, a cartel is only successful in raising prices by restricting production when the demand itself is highly inelastic, and that is why the Chilean-led copper cartel failed. So it is still a demand-side issue as well.

    Lastly, a speculator takes a long position on a commodity only because she intends to sell it, and if prices were likely to fall anyway, then she would not have speculated on a commodity where she was likely to lose money. So speculators were responding to reality; they were not changing reality.

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  11. You have to be careful with Libertarians as they make stuff up as they go along. Witness they history of computers.

    I presented the history of computers as it is presented in every computer science 0 history book and Libertarians (such as Jeffrey Tucker) still reject it. The percentage of "private sector funding" contributions, like IBM, is skewed out because a lot of their research funding was sponsored by the government.

    At Kling's blog, someone actually said that TCP/IP wasn't that big of deal because other people invented things like DHCP, DNS, etc., apparently not understanding the layered concept of TCP/IP in the first place.

    Still, conservatives have always done this. What's worse is the odd (psychotic) claims that Hayek did this or that or that computer science is "worthless" because it isn't guided by economics.

    I had to leave Daniel Kuehn's blog after reading those kind of comments.

    --successfulbuild

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  12. Successfulbuild,

    Nice comments.
    I have had this debate on the state intervention in the development of computers with libertarians before:

    http://krugman-in-wonderland.blogspot.com/2011/06/uh-mr-clinton-didnt-loan-guarantees.html

    See the comments.

    My first point:

    The early producers of computers could never have made it on their own without government subsidies and government contracts. Yet the modern computer only exists in its advanced form, because of decades of R&D that occurred when it was largely confined to the public sector:

    “Transistors were developed in a private laboratory, Bell Labs, but it was a monopoly. There was no market and there was no consumer choice. Since it was a government-supported monopoly, they could charge monopoly prices, which is in effect a tax. As long as they had the monopoly, Bell Labs was a very good lab. They did all sorts of things at public expense. As soon as it was deregulated, Bell Labs went down the tubes.

    Quite apart from that, Bell Labs was using state-generated wartime technology. Furthermore, they had nobody to sell the transistors to. For about ten years, the only market for high-quality transistors was the government, just like computers. During that period they were able to develop the technology, the scale, the marketing skills so that finally they could break into the market system.”

    David Barsamian and Noam Chomsky, Propaganda and the public mind: conversations with Noam Chomsky, p. 18.

    And the development of modern computers also occurred in Japan, where this happened by direct Japanese government industrial policy through their Ministry of International Trade and Industry (MITI):

    “The real success of Japanese producers, American industry sources conclude, came only after the mid-1970s. [The Ministry of International Trade and Industry] targeted the computer and telecommunications markets as central to Japan’s future. Establishing a national goal to lead in those industries, the government offered substantial incentives to encourage R&D and investment, besides restricting foreign access to Japanese markets.”
    Competitive edge: the semiconductor industry in the U.S. and Japan, p. 17.

    The Japanese industrial policy was so succesful that America semiconductor manufacturers were getting slaughtered by the Japanese by the 1980s.

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  13. Yes. Well, Chomaky has also pointed out the US also undermined Japan's semi-conductor production as well though. In the 1980s, Reagan-Bush forced Japan to raise prices for ships an to guarantee US producers a share in Japanese markets. They also poured a lot of money into our own industry, through the military system and through Sematech, which was a government industry consortium that was restricted to the US companies. The US was able to regain control of the more sophisticated end of the microprocessor market.

    Japan then started up its own goverment-industry consortium for semiconductors in order to compete. Neither had anything to do with markets.

    Those are great comments though, and I agree with them. I haven't read that book yet. Every other industry has had interferences like this, some more extreme and some less extreme. Let's also remember that IBM etc. got a lot of funding from the state, as did the networking industry. In fact you could say that IBM was born out of a company that was used for state purposes: Herman Hollerith and his tabulating machines.

    But some Libertarians go so far as to start distorting history or as to place certain technologies above others without knowing what they're talking about. I've had a Libertarian say the ENIAC wasn't a big advantage in computers -- and even some computer scientists have claimed it was just a big calculator, which is also definitely false.

    Anyway, here is the US army tree of computers:

    http://ftp.arl.army.mil/ftp/historic-computers/drawings/big-comp-tree.gif

    Notice where the root starts at the bottom.

    This tree has been criticized as bit US centric and there is another tree showing the ENIAC's predecessors (which weren't general purpose, electronic machines). But generally, the way I have presented it is the way it is taught to students in both high school and college.

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  14. I'd also like to point out that whatever Hayek or Mises supposedly did for this or that field (notice how the only people who seem to notice these "connections" tend are Austrian economists) would have to be pointed out by overwhelming evidence and quotes from experts in the field.

    The comments at that economics blog did not show that Hayek ever made a contribution to anything, only that he "observed" that certain words change over time or something or other.

    That's like "observing" that if I have two pencils and I add two pencils, I have four pencils, and calling myself a mathematician.
    The reason that this can be seen to be dangerous (or insane) is because it is a common characteristic of human beings to properly give credit to people who did the work and to recognize their genius. Most mathematicians understand, for example, that becoming a mathematician and publishing a few papers is pretty incredible. In fact, you're seen as doing pretty good if you can publish a few papers. But then someone like Cauchy comes along and publishes something like over 900 papers in a year. Everybody else is just in awe of his work.

    It's also pretty rare for someone to come along and make contributions that are applicable in several areas. I've thought about documenting exactly what Chomsky did and why it found major applications in some fields and minor applications in others.

    Btw... even bryan caplan has called this tendency to link Austrians to various fields nuts:


    Now what is Prof. Boettke going to tell you? I suspect that he is going to say that merely focusing on people’s erroneous beliefs “makes me an Austrian." I call this the “Hayek said the sky is blue" tactic. If you say the sky is blue, that makes you an Austrian because Hayek defended the sky-is-blue thesis back in the 30’s. Hayek talked a bit about mistaken beliefs; therefore anyone who ventures within a thousand intellectual miles of this topic is a “Hayekian.”

    This is ridiculous. By this standard not only does Hayek get credit for ideas that he did not anticipate; he gets credit for ideas that preceded his birth! Hayek made some contributions here - though frankly he was very repetitious. But he did little to advance modern rational expectations theorizing, and even less to anticipate its empirical weaknesses.

    and it is indeed nuts.

    --successfulbuild

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  15. Oops. Sorry. That should be 900 papers in his life.

    It's actually common in most fields now for undergraduate textbooks to go over the famous contributors. That is why in calculus books you have pictures of Caucy, √Čvariste Galois, and of course Newton and Leibniz and little biographies about their lives, etc.

    --successfulbuild

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  16. One cannot forbear playing the game of might-have-been. Here is the most likely scenario of awards from 1901 on: Bohm-Bawerk, Marshall, J.B. Clark, Walras, and Wicksell; Carl Menger, Pareto, Wicksteed, Irving Fisher, and Edgeworth; Sombart, Mitchell, Pigou, Adolph Wagner, Allyn Young, and Cannan; Davenport, Taussig, Schumpeter, Veblen, and Bortkiewicz; Cassel, J. M. Keynes, Heckscher, J. R. Commons, and J. M. Clark; Hawtrey, von Mises, Robertson, H. L. Moore, and F. H. Knight.(p. 358, n1)
    -
    Paul Samuelson, on what if the Nobel Prize was established in 1900, then who would have won the prize between 1901 and 1930?

    Yep, no one recognized the insights of Mises and Hayek or other Austrians.

    The Austrians were influential, American policy preference sadly did a lot to quiet the school for decades.

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