Monday, October 29, 2007

You don't need 20-20 vision to have seen how much more expensive it has become to fill your car with fuel in the last few weeks. Diesel has already topped the £1 per litre mark, and unleaded petrol is not lagging far behind.

The cause is a jump in oil prices. Oil is now trading at $89 per barrel, and some observers think that the $100 barrel is not far away. The immediate cause is tension between Turkey and the Kurdish population in northern Iraq - there is a fear that this might escalate to fighting that would disrupt supplies. Speculators are buying up oil with a view to selling it on once the price has risen further. This in itself is pushing the price up - both because such speculation increases demand and reduces supply to the end user.

Long term the price of oil will rise. The increased demand from rapidly developing countries, and the diminishing pool of easily accessed oil both serve to ensure that. But speculative blips happen along the way which cause fluctuations (down as well as up) of the price of petrol at the pump. What we have here bears all the characteristics of such a blip.

Wednesday, October 17, 2007

The news of a further sharp drop in housing starts in the US must surely fuel fears that a more general economic downturn is on the cards in that country. The work of Leamer (which I have referred to in an earlier post on this blog) links recessions firmly with the state of the housing market - and in particular with residential investment.

The Fed cut the headline interest rates in the US by half a percentage point last month. That is a sharp drop in one go. But it would appear that such a policy is needed to kick-start the economy before it swings into a full-blooded recession.

Monday, October 08, 2007

Michael Greenstone has recently released the results of a study into the effects of the Surge policy in Iraq. Based upon data from the world's financial markets, in particular on the price at which bonds issued by the Iraqi state are traded, he concludes that the Surge has been unsuccessful. To be specific, people are making their investment decisions as if the probability of Iraq defaulting on these bonds has risen by some 40%. This suggests that, far from improving security and stability, the Surge has made Iraq less stable.

The Surge has, however, improved various indicators of security within Iraq. This provides a puzzle - why is there a discrepancy in the results. One possibility is that the indicator based on bond prices is more comprehensive in that it captures a measure of overall confidence in Iraq. Another possibility is that this measure is based on the assessment of people who, for the most part, have no direct experience of Iraq, and whose information may be flawed.

While Greenstone's work provides an intriguing measure, therefore, the jury has still to be out on whether the Surge has been a success.
Edward Leamer has recently produced work on the link between housing and the business cycle. He makes a compelling case in arguing that residential investment is an important leading indicator - and that looking at changes of residential investment over time can provide early warning of turns in the business cycle.

His analysis suggests that the US is heading for a recession. The recent interest rate cuts introduced by the Fed suggest that the policy response is already under way.

We all know that when America sneezes, the rest of the world catches a cold. The signs are that the next 18 months or so may prove to be a bumpy ride.