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Clear Thoughts
Will the price of oil cause another recession?
Originally Published Friday, 12/10/2004
| The rising price for oil is not the only potential trend that could lead to a recession. Job erosion, economic development, and international affairs are all potential recessionary trends. How do these trends effect the economy and our lives? |
There are a host of responses to this question being offered up by interested parties. Among them are: "Maybe", "Definitely", "No, something else will cause a recession first (i.e. loss of jobs, interest rates, etc.)" and "What recession?"
In the late 90's, it was generally believed on Wall Street that the U.S. had outgrown its dependence on oil. At least it seemed that nobody believed high oil prices could be as seriously detrimental to the economy as they were in the 70s. The popularly agreed upon argument was that since our energy costs were less than 6% of our national activities, they were considered relatively inconsequential. We had risen above the supply problems which had beset us in the past decades, and benchmark oil was about $18 a barrel.
Many economists believe that in large part this was because we are no longer a nation of manufacturers. The service economy was driving our economic engine and we were soaring in the rarified zone of high technology.
That was the backdrop in the late '90s. But since then several macroeconomic trends that can contribute to a recession have evolved. Although oil prices figure into many of them, it's not the only key driver.
First, job erosion happened. Immigration, legal and otherwise, outsourcing jobs to Mexico and points east, robots, lay-offs, etc; all of these can contribute to a less than full level of employment. If this continues some may be asking if job erosion could cause recession. The logic behind this argument is that if people fear for their jobs, they will spend less on goods. Carrying this thought a step further, if corporations see a decline in consumer spending, they could invest less in their inventories, in labor and - even worse for long-term sustainability and growth - R&D and infrastructure. Hence a downward spiral could occur. A "balance sheet driven recession" would then begin, whereby investment is postponed and debt is minimized.
In another important economic development, China's tremendous growth in the world of manufacturing has become a huge story. China's rapidly expanding economy requires oil. Napoleon once said "Let China sleep." That was a long time ago somebody woke her up and in her early dawning stretch she found she wants oil almost as much as we do. This adds to an already existent global oil supply problem. Now demand for oil is growing by multiples, while supply is increasing by single digit percentages. Solely due to world-wide rising demand, oil is going to cost more and therefore will take more out of our weekly allowance to satisfy our need for it. There is only so much money in the wallet and if we tank up at higher prices it means we cannot buy something else. This is another potentially recessionary trend.
Of course international affairs are also cause for concern. Terrorism is a fact of international life. This causes some of us to contract our activities. The Iraq conflict goes on. Iran and North Korea are huge unknowns. This results in enormous amounts of our wealth being dedicated to war activities. Besides adding to federal deficits, today, most economists agree that after the first flush of monies profitably swirling in the military-industrial complex, war will be a drag on the economy.
Meanwhile we have an anomaly. There is no figure which tells us how much is a "fair" price for oil. By "fair" we mean a price which does not negatively impact our lives. Yet there are understood benchmarks for much of the rest of our lives. We have "par" for bonds. Even golf has a par. We have 98.6 degrees for our body temperature. At 103 we are very sick. Over 109 we die. We understand these numbers.
Even with its proven importance, we do not have a barometer for our energy needs and costs. When gas at the pump is up from yesterday, do we wish we had bought it the day before? Remember it was at least 20% cheaper a year ago? And yet when benchmark oil prices reached over $55 per barrel a few weeks ago, it was high, but not as high as it was in the crunch of the 70's, adjusted for inflation. But it seems only a short while ago that oil dropped to $11 a barrel.
What is right? What is reasonable? This brings us back to the "Big Question" will oil prices cause a recession?
At what price will oil cause us to stop driving SUVs and force us to wear thermal underwear inside our homes in the winter? We not only do not have an exact figure, we barely have a rudimentary feel for what is what on this increasingly important issue. So it seems our confusion will remain until we have more clarity on where supply is going and how fast demand is going to grow in the mid to long term. Until then it seems we're stuck in a "Crude" mess (oil that is).
As energy prices impact company fundamentals, our computers will seek out energy losers and winners. Stay tuned.
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