The “inflation or deflation” debate rages on.

We quite liked Gregor Macdonald’s view a few weeks ago that we could be headed into an environment where both inflation and deflation take hold — an economic climate we termed “compartflation”. Others have spoken about ‘indeflation’, although in our opinion that term doesn’t quite reflect the compartmentalised nature of the phenomenon, especially with regard to commodities.

The Oil Drum has now picked up on the debate by reprising a post by Chris Nedler, an energy analyst and journalist, which adds one important facet to the argument: the monetization of oil. As he wrote:

I don’t want to make too much of the commodity resurgence, however. The market continues to price oil inversely to the dollar, and the dollar’s fall has been echoed almost perfectly by oil prices:

Dollar oil inverse relationship - The Oil Drum

Instead of just looking at the dollar and inflation, we should consider that, as former International Petroleum Exchange head Chris Cook argued on The Oil Drum, energy is the only real currency. Our fiat money is but a distorted representation of it, and that energy is declining in real terms as oil, natural gas, and coal all become progressively harder to extract and of lower energy content.

And he adds (his emphasis):

It now seems possible that we have reached an inflection point in economic history, where the price at which energy is high enough to sustain new production is the same price at which things become too expensive, leaving us no option but to downsize.

And here’s the critical point if that is true:

Until we understand this key point, we are going to continue to go through wrenching cycles like we experienced over the last year. Spiking energy and commodity prices lead to destruction of the economy, which then gathers itself at a lower overall level until prices spike again, and back around the wheel we go. As energy declines, the ceiling will get lower and lower, and it will take more and more money to buy the same things. No amount of tinkering with monetary policy can change that. Unlike money, Btus can’t be printed out of thin air. Unfortunately, neither the Fed nor Congress seems to have learned this lesson.

So if energy is the new world reserve currency, Jeff Korzenik — a prominent US commodity commenter — makes a very salient point over at (in)efficient frontiers (emphasis his):

If we’re going to trade crude oil like a currency, we should regulate it like a currency, too.

He goes on to present a proposal first put forward to the US House Committee on Agriculture by commodity specialist Tom Rooke. As Korzenik, who has also testified before congress on the matter of speculation and oil prices, explains:

Rooke’s proposal, in essence, regulates crude oil much like some of the ways that money supply is regulated. In his creative structure, the U.S. would require that holders of crude be required to maintain a reserve requirement which would be controlled by a central governmental authority, much like the Federal Reserve can change reserve requirements for banks. This would raise the costs of hoarding crude (probably not a bad thing), represent a second, private strategic petroleum reserve in event of national emergency (definitely a good thing), and provide a stabilizing buffer in crude oil pricing (much like what OPEC used to do when it had more market power).

In the proposal, the initial transition period and reserve buildup would be eased through using depository receipts issued by the Strategic Petroleum Reserve. Tom’s submission can be read here: TWR Letter. The specific proposal starts on page 10, although the earlier pages include a discussion of index speculation and the evidence that it was impacting crude oil prices. It’s worth noting, that at the time the crude oil futures were in clear backwardation and the impact of speculation was more muted (Tom estimated 10% of price increases, I guessed around 20%); with the contango markets we’ve seen more recently, speculation plays a more direct and potentially greater role.

Which actually sounds very similar to the idea first proposed by Chris Cook, a former director at the International Petroleum Exchange and now an active consultant to the industry. As referred to by Nedler, Cook’s idea rests on energy producers worldwide beginning to issue units redeemable in energy.

Related links:
It’s not a liquidity crisis, it’s an energy crisis stupid
– FT Alphaville
A commodity anchor, or oil as money
– FT AlphavilleCompartflation – FT Alphaville

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