tag:blogger.com,1999:blog-17908317.post4252188589337227129..comments2024-03-15T20:20:47.934-07:00Comments on Unenumerated: Commodities, currencies, and the St. Petersburg paradoxNick Szabohttp://www.blogger.com/profile/16820399856274245684noreply@blogger.comBlogger2125tag:blogger.com,1999:blog-17908317.post-680702657098388712008-06-30T15:56:00.000-07:002008-06-30T15:56:00.000-07:00On the subject of substitutability, more comments ...On the subject of substitutability, more comments I made elsewhere:<BR/><BR/><I>The problem [with substitutes like coal gasification, tar sands, etc.] is that higher inflation expectations must be built into cost estimates for them. It's no good to say that coal gasification cost only $80/barrel last year, for example, and so it must be cheaper than oil at $140/barrel. One has to figure out how much a coal gasification plant will cost over its future lifetime given the higher expected inflation. The cost ratio for coal gasification or extracting tar sands to the cost of extracting Saudi oil hasn't changed, it is still more than a factor of 10 higher. As inflation spreads from gold and oil (where it appears first) to other commodities, and then to wholesale prices, then to retail prices, then to labor costs, we will see the nominal costs of tar sands, coal gasification, nuclear power, wind power, and so on catch up to the nominal price of oil. The relative real costs of all these sources haven't changed much, and won't change much, unless there is some joker discovery like a great improvement to biofuels due to genetic engineering. (It is true that the nominal attractiveness of these alternatives to oil increases the R&D into alternatives and thus increases odds of such a joker occuring per year). Nevertheless, it's probably the case that only nominal relative costs, rather than real relative costs, have and will substantially change due to inflation expectations hitting gold and oil prices before they hit other kinds of prices.</I>Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-17908317.post-27258604537721434202008-06-30T15:53:00.000-07:002008-06-30T15:53:00.000-07:00Here's a comment I just made on another blog to il...Here's a comment I just made on another blog to illustrate how rapidly commodity prices can change with small changes in inflation expectations (you can check the result using the "NPV" or similar function in your spreadsheet):<BR/><BR/><I>Increased expectations of inflation in future decades, from 1998 (near the end of a decade when deflation was the main worry) to today (even Alan Greenspan said in his recent book to expect 4.5%/year from here on out, and that was well before the Bear Stearns bailout), can easily account for a factor of 14 increase. For example, a Hotelling nonrenewable commodity for which there are no changes in expected consumption (assume the expectation covers the next 100 years), but there is a change in expected inflation from 1.75%/year over that time to 4.50%/year over that time, gives us a factor of 14.3 increase in the commodity price.</I><BR/><BR/>Of course, as the St. Petersburg paradox suggests, the 100 year figure is somewhat arbitrary. Restrict the time horizon to 50 years and the inflation expectations have to increase more dramatically, e.g. from 1.0% to 6.5%, to translate into a factor of 14 increase in the price of a Hotelling commodity. At the other extreme expectations over 200 years need to only increase from 2.6% to 4.0% to account for that factor of 14.<BR/><BR/>If you are a Saudi prince who can expect his great-granchildren to still own a share of the Saudi oil fields in 200 years, the 200 year figure is appropriate, but in most other cases property rights are less secure and shorter timeframes are appropriate. Furthermore, there are too many technological jokers over 200 years to expect the non-substitutability assumption to hold (for example, somebody might genetically engineer a cheap biofuel).Anonymousnoreply@blogger.com