So, inflation is at 12%. The rate of increase of inflation is however coming down if second derivatives console you. Yet, there are good signs. The price of crude oil has come down from its July 11 high of $147 to $117 now. It rose from $60 in April ’07 to $90 by February ’08. Then it accelerated to $130 by June. At this point the question was whether this was a bubble, or was the rise justified by fundamentals. This is one of the trickiest questions to settle in economics. When a market is on the up, everyone thanks fundamentals for it; when it is crashing, they run about telling us not to worry since the fundamentals are right and so the fall is temporary. Those who swear by the efficient market hypothesis, only like it on the up, not down.

I took the view last June that this was a bubble caused by the ability of US pension funds to invest in commodity tracking funds in which they were taking a one-way bet. The stake of pension funds had gone up from about $30 billion to $230 billion and 80% was going into oil. There were rumours of the world running out of oil (as there are every ten years or so) and talks of oil hitting a spike of $200 a barrel. But it was hard to discern any change in fundamentals between ’07 and ’08 which would justify such an acceleration of the rate of increase—another second derivative going the wrong way. The daily balance of oil supply and demand showed a gap of about a million barrels either way, and that had not changed. The traders who were buying futures to make or take real deliveries of oil were being crowded out by the financial traders who dealt in paper contracts and had no intention of taking or making deliveries.

If this rise was a bubble, then it would dissipate itself, if fundamentals were not right. The question was when would such a bubble burst. The dotcom bubble lasted five years and Alan Greenspan happily went on feeding it with a lax monetary policy. At that time, the fundamentalists were saying, this was a new paradigm, etc., which they always say in a sustained bull market. But in that bubble we were dealing in paper assets, and no real discomfort to consumers or producers Oil is different. The discomfort of the real traders was growing palpable, and consumers were paying more at petrol stations and truckers were striking.

There is always a temptation to close the markets down or put a cap or sack the regulators. But those things never work, not in a global context. One has to devise policies which go with the flow of the market. The only market-consistent way to help the bubble burst was to change the margin requirements which the financial traders paid relative to the real traders. I proposed that the margin be raised from 7% to 50%. The margin is paid back when the transaction is done, so it was a temporary raising of transaction costs.

Still, as politicians and analysts complained about the financial speculation in oil, we were treated like children. Markets, we were told, never get it wrong and this was just nonsense. The US Congress began hearings on how to curb the oil price inflation. But here again what was needed was not bans and caps but devising a market consistent way of tackling the financial surge.

Now that the bubble is deflating if not bursting, what are the lessons? It could be that the mad rush into the commodity tracking funds was fed by ‘irrational exuberance’, and the credit crunch made it more difficult to sustain the bubble despite low interest rates in the US.

Commodity prices are coming down from their peak of a few months ago and this may bring inflation down. For the government of India, here is a chance to catch up with the absurd deficit on the oil account. I hope no one argues that the subsidy should be raised again since the price is down. The deficit is estimated at around $50 billion for ’08/’09. With that kind of money, you can give each of India’s billion people a $50 tax cut. So, please no slide back, and even better, implement the sensible suggestion of the Chaturvedi Committee that the petrol price should go up by a rupee each month. If the UPA really cares about aam aadmi, they should stop subsidising the auto aadmi and maybe charge double for every car with a red light on top!