High oil prices cause slumps: But this time it’s different. Isn’t it?

China and the US are driving up oil prices but their economies keep the global economy afloat

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By  Nicholas Wilson Published  October 4, 2005

Rocketing oil prices triggered three global economic slumps in 1973, 1979, and 1990, so why should this year be any different? Economists, of course, don’t agree on the outcome--a satirist once said that economists spend half their time explaining what will happen, and the other half explaining why what they said would happen, didn’t. But many feel that the world economy this time will escape an oil crunch. Oil prices seem to set new records monthly, no matter what the time of year: Gulf of Mexico hurricane season, northern hemisphere winter, US summer driving season. And the fingers never stop pointing nor the excuses flowing: speculators, greedy gas-guzzlers, environmental regulations, short-sighted politicians, murderous warlords, over-heating economies, mother nature, among others. Yet while no one agrees on the cause, there is a consensus that something should be done about it. Even OPEC, whose members hop, skip, and sing as they carry bags of cash to their bank vaults each night, want to get a grip on soaring energy costs. But perhaps the economic fire fighters are piling into their vehicles before there any flames to put out. The usual pattern of an oil-induced recession starts with a non-consumer factor such as an embargo, a war or revolution, cutting supplies and driving up oil prices, and inflation. Central banks deploy their most powerful inflation-busting weapon--interest rate hikes--companies rein in investment, consumers tighten their belts spending less and saving more, factories close, and Adam Smith’s “unseen hand” of economic forces throws workers out on the streets. This time, however, it is a booming world economy that can’t gargle enough of the black stuff, especially the two energy-thirsty giants, China and the US, that is punishing motorists at the pumps. Economists watch Lady Liberty’s economy like a hawk for signs of inflation or rapidly rising interest rates, and still manage to get plenty of sleep at night. Across the Pacific Basin, hundreds of millions of the Dragon’s dollar-a-day workers continue forging cheap products in its economic furnace: products that keep US inflationary fires under control. With its constant flow of export-earned dollars China purchases more oil for its furnace and buys more US government bonds. The bond-buying spree lends Lady Liberty cash, which keeps her borrowing costs down and her low-interest-rate financial powerhouse nicely purring along. It is the booming US and Chinese economies that drive the demand for oil and its prices up. Today’s oil-price spike is not at all like previous ones that burst the boiling oil bubble as producers scalded the hand that fed them. In 1973, Arab oil producers cut back oil supplies to hike prices and punish the West for supporting their arch-enemy Israel, with which they had just fought another war. Six years later Iranian revolutionaries deposed the pro-Western, oil-pumping Shah and took hundreds of US diplomats hostage in their Tehran embassy. The resulting showdown and US-encouraged Iraqi invasion of Iran piled pressure on neurotic oil markets. In 1990 Iraq invaded another neighbour, this time without anyone’s approval, with the aim of seizing Kuwait’s 10% of global oil reserves, which would have left Iraqi artillery on top of one fifth of the world’s oil that lies on both sides of the border. Other major factors also make the trajectory of today’s price-meteor different from its predecessors’. In 1973, oil accounted for 8% of the world’s gross domestic product, compared to today’s 2%. In contrast to three decades ago, oil energy efficiency, in terms of dollars of GDP produced per barrel of oil consumed, the US today is 100 more efficient, and 50% more efficient compared to during the 1981 price spike. And taking inflation into account, in real terms the price per barrel when Iranian students stormed the US embassy was US$90. Furthermore, oil prices doubled in six months. In contrast, the cost of today’s oil took three times as long to double. In fact, consumers and companies have had four years to adjust since the price bubble started rising through viscous commodities markets from the November 2001 price of US $18 per barrel for West Texas Intermediate. US motorists may sigh with nostalgia as they remember those times that may have gone forever. So far the pulsing economies on both sides of the ocean seem to be absorbing the oil price punches, and it’s still business as usual for them. But there’s no reason for complacency: the skin-tight market leaves little room for maneuver should a geopolitical left hook, such as those in previous decades, catch the Lady and the Dragon off guard as they lie in a shared bed, drinking deeply from their barrel of cheap loans and oil. Or perhaps another freshly sharpened oil-price spike will burst Lady Liberty’s consumer bubble and deflate her economy, leaving the optimistic economists to explain why what they said would happen, didn’t. Nick Wilson Editor nicholas.wilson@itp.com

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