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.”A quick review of the instances when the US has released capacity from the Strategic Petroleum Reserve confirms its effectiveness:
Paul Davidson, “Crude Oil Prices: ‘Market Fundamentals’ or Speculation,” Challenge 51.4 (July/August) 2008, pp. 10–11.
(1) 1990–1991: Desert Storm sales of 21 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.
(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.
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.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.
Bill Mitchell, “An International Currency? Hopefully Not!,” Billy Blog, November 3, 2009.
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.