Krugman's wrong on oil prices

Oil prices, currency prices, and quantitative easing are all interconnected, in ways Paul Krugman recently oversimplified.

By , Guest blogger

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    An oil rig drills in Long Beach, Calif., Oct. 5. Oil prices respond to many factors, including the quantitative easing ('QE2') proposed by government economists.
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Paul Krugman argues that competitive devaluations won't raise the price of oil:

"Why do dollar commodity prices tend to rise when the dollar falls? Because other countries buy commodities too, so that a constant dollar price would mean a fall in terms of other currencies. To a first approximation, in fact, you’d expect commodity prices to remain constant, other things equal, in terms of a GDP-weighted basket of currencies around the world.

So yes, a fall in the dollar tends to raise the price of oil in dollars — but it also tends to reduce the price of oil in euros. A fall in the euro tends to raise the price of oil in euros, but raise reduce it in dollars. [whoops!] So what would devaluations that raise commodity prices in terms of all currencies look like? I have no idea.

There is, I think, a tendency to think of devaluations as reductions in the value of currencies relative to something external and eternal — and hence as making us all poorer. But the reality is that my depreciation is your appreciation, and vice versa; we can’t all devalue at the same time."

Actually, Krugman is entirely right about this, assuming that it involves exchange rate movements unrelated to monetary policy easing. However, he misleads when he tries to create the impression that this is applicable to this case, as the latest decline in the dollar's value (and corresponding oil price increase)is clearly related to the latest round of "quantitative easing".

While depreciation/appreciation of currencies relative to other currencies is indeed a zero sum game where one country's depreciation must be another's appreciation, inflation is not a zero sum game between countries, and one country can certainly have higher inflation without others having disinflation or deflation. Indeed, it is possible for all countries to simultaneously have higher inflation.

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And because it is caused by "quantitative easing" the dollar price of oil will increase even as oil prices in terms of euros, yens, yuans etc. don't decrease. Indeed, because oil, like other commodities, has a more flexible price than normal goods, American "quantitative easing" could at least in the short term increase oil prices in terms of even other currencies. This is of course especially true if other countries pursue similar policies to limit the appreciation of their currencies.

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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. This post originally ran on stefanmikarlsson.blogspot.com.

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