With oil prices spiraling north of $35 this month and feeding into the anxiety reflected both in the back up in bond yields and the euro’s faltering performance, reversal of the spiral seen thus far has contributed to restoration of some calm on both fronts. Price relief might end up as only a fleeting response to the politically inspired tapping of the Strategic Petroleum Reserve. Increasingly, though, it seems that the SPR release could turn out to be an important element in a longer-lasting change in market dynamics that will cap prices near current levels and continue exerting pressure for a sustained price decline back toward equilibrium levels. As a first step, the move seems to have altered market sentiment sufficiently to unwind the hoarding premium that was adding as much as $5 per barrel to the price by some estimates. More significantly, though, the decision could end up creating incentives for OPEC – whether officially or not – to further increase production and drive prices down further.  Surprisingly enough, Paul Krugman’s column in today’s New York Times gets this part of the story basically right, and I’ve been involved in a running debate on the issue on the MetaMarkets.com website.

Recognizing that prices at current levels are unlikely to be sustained long-term, the primary objective of many OPEC members is to maximize short-run revenues. Crude futures dated beyond next June are now priced below $30 per barrel, and about $25 two years out, which is probably at the high end of a reasonable range of expectations. Maximizing gross revenues in a declining-price environment is accomplished, to the extent possible, by increasing production. Undoubtedly, there is sentiment among more radical OPEC members to offset the SPR release and keep prices high by cutting production. Such restrictions would be unlikely to survive, though, particularly if the U.S. and other industrialized-nation governments keep open the option of additional reserve releases. At some point, quota cheating by individual OPEC members would likely break apart any attempt by the organization to impose restraints.

Concerns about the heavy hand of government intervention are not easily dismissed. But they have considerably less weight in the context of a market being openly manipulated – at potentially heavy costs to global economic well being -- by a producer cartel entirely composed of state-owned monopolies.         

THE GOOD NEWS IS, HE’S GONE. One of the more influential figures of the past decade or so among the Fed’s band of nameless, faceless, string-pullers is warning that the rate-hiking cycle is probably not yet concluded. “I think there is a considerable chance we will see some rise in the funds rate in the next six months as the Fed responds to evidence of further deterioration in inflation trends,” Michael Prell told a gathering arranged by ISI Group this week. Fortunately, though, Prell’s 30-year tenure at the central bank, the last 13 as research director, ended in June. In fact, it’s probably no coincidence that Prell’s departure coincided with first indications surfacing that the Fed’s headlong commitment to growth restraint was facing internal resistance.

As primary compiler of the Green Book,the forecast prepared for each FOMC meeting which sets out the Fed’s policy options, Prell was a leading adherent to the flawed Phillips-Curve/output-gap prescription for using monetary policy to fine-tune real economic outcomes. He was also known as a masterful bureaucratic operator highly adept at successfully engineering a fait accompli for the staff-favored policy outcome. In support of his contention about deteriorating inflation trends, Prell told the ISI assemblage, “scarce workers are beginning to exploit their leverage by demanding more money.” Of course, the notion that limiting wage gains is one of the primary missions of monetary policy is deeply ingrained among senior staff economists at the central bank. His successor, Yale Ph.D. David Stockton, represents no departure in that regard. Stockton, though, is regarded as flexible and open-minded enough to entertain the possibility that productivity trends have substantially increased the economy’s growth “potential.”  

CPI ERROR KERFUFFLE.  For those unpersuaded by the consistently restrained gains in reported inflation in the face of generational lows in unemployment and continued strong growth, this morning’s Washington Post must have been a welcome sight. “Inflation Higher Than Reported,” said the headline on the piece by John Berry, the Post’s long-time economic correspondent and a favored vehicle for leaks by the senior Fed staff.  Berry reported that the Bureau of Labor Statistics was about to upwardly revise its calculation of consumer price inflation over the past year by up to 0.3% due to an overestimation of quality improvement. “A revision of this magnitude won't please either Federal Reserve officials or investors, because to some extent both have been unhappy with the acceleration this year of both the CPI and the core portion of the index,” Berry asserted.

Turns out, though, Berry’s report was itself erroneous in several respects. The BLS, in a statement issued late this morning, said a computational error discovered in the software used to calculate the rent components of the index would mean only a 0.1% increase in the CPI as calculated between December 1999 and August 2000, from 2.6% to 2.7%. Berry’s assessment no doubt was accurate enough with regard to Fed officials looking for any rationale that can help justify clinging to their discredited model. The markets, though, know that acknowledgement of a 0.1% error over the last eight months is dwarfed by the myriad statistical distortions and erroneous assumptions that are presented as objective fact on a month-to-month basis.