Tuesday 25 July 2006

Pic of the day: The piggybank and I - economics for beginners. ^^

Bernanke and the strawberries

You know, that sounds like a good name for a band. But anyway, Ben Bernanke of the Federal Reserve has recently taken some flak for being soft on inflation. Now, I am not his greatest fan, but I totally agree on this one. Because this inflation is pretty near entirely oil-driven.

The spike in oil prices doesn't just show up at the gas station. It is also in your air fares and to some degree in your utility bill. (Not fully, since there are also some coal plants.) More to the point, every object that is transported for any length will become more costly. In these days it is considered perfectly normal to eat strawberries that are picked at the other end of the continent. Many consumer goods are produced at the other side of the globe. Of course oil prices will leak into the rest of the economy! Even if they were to plummet now, it would take months before the effect wore off.

But this also means that further inflation depends on steadily higher oil price. And even if that were to happen, we would soon reach the point where other energy sources became commercially viable. In fact, they are already phasing in. Nuclear power plants are becoming popular again, after being on the decline since the end of the cold war, when they were seen as symbols of evil. It takes time to build new power plants, but the process is already started in several countries. The new plants are safer and more efficient, too. Meanwhile, windmill parks are being set up in most western countries, including the USA. This still depends on government subsidies to some extent, but with higher energy prices this should change. Ironically, constructing these windmills and transporting them to their destination takes quite a bit of energy, mostly provided by oil... but again, this contributes to the current peak, and is not a running expense.

Solar energy is also on the verge of widespread use if energy prices continue to rise. Not just solar cells or solar towers in the desert, but sun catchers to heat water for ordinary houses. The sole reason these are not catching on is aesthetics. What would the neighbors think if we had weird black radiators on the roof? But these would be able to provide hot water for the household much of the year, either directly in the hot zones or with the help of a small heat pump in more boreal tracts. Heat pumps provide heating in the winter at a much lower energy cost than traditional heat sources. All of these things grow more and more popular as energy prices soar. It is a soft slope, but gradually the oil price will stop rising and then begin to fall back, even if we should not see a collapse in the economy of any large country. Which we probably will, too.

But even in the best case scenario, with continued rapid economic growth, habits will change over time. When we eat food from all over the world now, it is largely because transport costs are negligible. If this is no longer the case, people will gradually begin to grow more crops locally, as they can suddenly compete on price again with food that is grown far away. It is the same with industry. Today ores are often shipped halfway around the globe to be processed into metal, which is then shipped to another continent to make parts, which are shipped off again to make various items which are brought back to be sold. This is perfectly rational with the fuel prices we are used to, but if they remain much higher for much longer, industry would adapt to reduce transport costs.

On the other hand, labor costs are not rising, as they were in earlier periods of inflation. Nor are they likely to for a while, until the world economy has adopted the roughly 1 billion workers added when China, India, Brazil and other developing countries joined the global market economy. People who had tended their small farms began moving to the towns to work in the industry, and any wages that could fill the stomach sounded good. They are getting more picky over time, but new laborers are still joining. In this situation, rapid wage hikes seem unlikely in most of the world, although countries with a very large service sector (like Scandinavia) may have local wage increases at the expense of their industry.

In short, there is reason to be relaxed about inflation. As long as laborers are not scarce enough to demand corresponding wage increases, they will be the ones squeezed by the inflation. This will reduce consumption, first and foremost of luxuries. And that's just what the doctor ordered to squelch inflation. So, basically, inflation will halt inflation this time.

But you may have to eat locally grown strawberries in the future, even if they are slightly smaller than the ones you are used to.