Monday, May 12, 2008

Krugman, oil nonbubble

Paul Krugman today argues in NY Times that we don't have oil bubble. His usual argument is that if this was speculation, there should be an inventory buildup. I think he's wrong and his argument is inconsistent.

First, oil demand, just like food, can be very inelastic, i.e., demand will not fall much even with rising oil price. For the same reason, with a small decrease of supply, even without much increase of demand, price can rise sharply.

Second, Krugman himself admits due to driving habit, infrastructure layout, and policies, it's very hard for people to adjust their behavior within a short period of time.

I tend to think the current runup of oil price is mainly due to falling dollar, supply constraint, and most importantly, speculation. What differs from previous times is the availability of a lot of new financial instruments for both institutional and individual investors to speculate on oil and other commodities. Yes, I have ETF in mind.