I get a lot of requests for permission to reproduce graphs from CD for publication in various books and articles, and I’m always happy to comply – I’m not even sure they really need my permission as long as they credit the source (e.g. my graphs appear on a regular basis as “charticles” in the Washington Examiner without prior permission, and that’s perfectly fine with me), but maybe it’s just to be safe legally. Last week, I got a request for permission to reproduce a version of the graph above, which originally appeared in the 2010 CD post ”Julian Simon: More Right Than Lucky,” and was also featured on Marginal Revolution. I hadn’t thought about that graph and post for awhile, but the request prompted my memory and motived this update.
My February 2010 post was in response to Paul Kedrosky, who re-visited the famous 1980 Simon-Ehrlich wager on the inflation-adjusted prices of five commodities (nickel, copper, chromium, tin and tungsten) in the decade between 1980-1990. Paul used updated price data for those five commodities in 2010, and concluded that:
“It will surprise no-one that the bet’s payoff was highly dependent on its start date. Simon famously offered to bet comers on any timeline longer than a year, and on any commodity, but the bet itself was over a decade, from 1980-1990. If you started the bet any year during the 1980s Simon won eight of the ten decadal start years. During the 1990s things changed, however, with Simon the decadal winners in four start years and Ehrlich winning six – 60% of the time. And if we extend the bet into the current decade, taking Simon at his word that he was happy to bet on any period from a year on up, then Ehrlich won every start-year bet in the 2000s. He looks like he’ll be a perfect Simon/Ehrlich ten-for-ten.”
So what does it all mean? Again, according to Paul:
“First, and most importantly, it means Simon was right but fairly lucky. There is nothing wrong with being lucky, of course, but compulsive Simon/Ehrlich-citers need to be reminded that it is no law of nature (let alone of rickety old economics) that commodity prices (inflation-adjusted or otherwise) trend inexorably downward, even over a decade.”
My response then was as follows:
It should also surprise no one that a commodity bet’s payoff is not only highly dependent on the starting and ending dates, but also on the specific commodities chosen. In the famous bet, Ehrlich chose the five commodities that he thought would become scarcer, but a more complete analysis of commodity scarcity and prices over time shouldn’t be restricted to only those five commodities, and the time periods evaluated shouldn’t be restricted to just decades.
The chart above shows the monthly, inflation-adjusted Dow Jones-AIG Commodity Index back to January of 1934 (data from Global Financial Data, paid subscription required, adjusted for inflation using BLS data) – originally through February 2010 and now updated with new data through January 2013. The DJ-AIG Commodity Index is composed of futures contracts on 19 physical commodities (e.g. crude oil, natural gas, live cattle, zinc, nickel, copper, silver, cotton, aluminum, silver, etc., see the full list and current weights here).
Not mentioned in my original post was the fact that two of the five metals in the Simon-Ehrlich bet are included in the DJ-AIG Commodity Index: copper and nickel.
The red line in the graph shows the statistically significant (p = .0000) downward trend in inflation-adjusted commodity prices since the 1930s, and I therefore concluded in 2010 that:
I’m not so sure that Simon was just lucky. If Simon’s position was that natural resources and commodities become generally more abundant over long periods time, reflected in falling real prices, I think he was more right than lucky, as the graph above demonstrates. Stated differently, if Simon was really betting that inflation-adjusted prices of a basket of commodity prices have a significantly negative trend over long periods of time, and Ehrlich was betting that the slope of that line was significantly positive, I think Simon wins the bet.
Now that almost three years have passed since the original post, what’s happened to the commodity prices captured by the DJ-AIG Commodity Index? Between early 2010 and the summer of 2011, the DJ-AIG index increased by 28.5%, partly because oil prices increased from $80 per barrel to $110, and gasoline prices increased almost 60% from $2.50 per gallon to almost $4.00. But since the summer of 2011, the commodity index has fallen back to the same level as in early 2010, thanks probably due to falling natural gas prices, and declines in the prices of copper, nickel and aluminum. As of January 2013, the inflation-adjusted commodity index is at about exactly the same level as January 2003, reflecting a flat price trend over the last decade.
The updated chart also shows that the world population in 1934 was about 2 billion people, and we now live in a world with almost 7 billion people. Therefore, over a period that includes several generations or more, we see an overall significant downward trend in real commodity prices, despite an increase of more than 5 billion people in the world. Overall, I still conclude that Julian Simon was more right than lucky.