Julian Simon: More Right Than Lucky
Paul Kedrosky re-visits the famous Simon-Erlich bet. Alex Tabarrok responds here. Paul wrote:
"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."
MP: 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). The DJ-AIG index is composed of futures contracts on 19 physical commodities (e.g. natural gas, live cattle, zinc, nickel, copper, silver, cotton, etc., see the full list and current weights here). (Note: According to Global Financial Data, data in the index from 1933 to 1989 are from the Dow Jones Futures Index, and data from 1990 are from the Dow Jones-AIG Commodity Index.)
The red line in the graph shows the statistically significant (p = .0000) downward trend in inflation-adjusted commodity prices since the 1930s.
Paul Kedrosky: So, what does all this mean? A few things. 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.
MP: 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 slope over long periods of time, and Ehrlich was betting that the slope of that line was significantly positive, I think Simon wins the bet.
Update: By request, data available here.