All but one of the U.S. recessions since World War II have been preceded by a dramatic increase
in crude petroleum prices. Recent turbulence in energy markets has some analysts speculating that,
in the immortal words of Yogi Berra, it could be deja vu all over again. But this oil price shock
differs significantly from earlier episodes, leading me to believe that the economy will be able to
adapt to the new pricing environment without a major economic slowdown.
| Date | Event | Drop in world production |
|---|---|---|
| Nov. 1956 | Suez Crisis | 10.1% |
| Nov. 1973 | Arab-Israeli War | 7.8% |
| Nov. 1978 | Iranian Revolution | 8.9% |
| Oct. 1980 | Iran-Iraq War | 7.2% |
| Aug. 1990 | Persian Gulf War | 8.8% |
In each of the five biggest previous oil shocks, there was a dramatic geopolitical event that
cut oil flows amounting to nearly 10% of total world oil production. For example, when Iraq
invaded Kuwait in August of 1990, oil shipments out of the countries, which between them had
previously been producing 5.3 million barrels a day, completely ceased. The price of West Texas
intermediate crude went from $18 in July 1990 to $36 in October, doubling in the space of three
months.
This dramatic price spike led to abrupt changes in the patterns of spending on the part of U.S.
consumers and firms. For example, new car sales fell 17% between September 1990 and January 1991.
These changes in spending resulted in idle capacity and layoffs in key business sectors as the U.S.
went into its ninth postwar recession.
By contrast, global oil production has increased steadily during the current episode. The
run-up has been caused this time not by a shortage of supply but rather by booming world demand
(see What’s up with oil
prices?). The strong world economic growth that produced this demand overall must be regarded
as good economic news, not bad. And although we have again seen West Texas intermediate nearly
double from $28 in September 2003 to $54 today, this time the increase required a year and a half
rather than just three months.
Both the gradualness of the price move and the circumstances attending it have left consumers
and firms substantially less nervous about the current economic situation than they were in August
of 1990, with none of the postponing of spending decisions that characterizes most economic
downturns. U.S. car and light truck sales are only down 1% for the first five months of 2005
compared with the first five months of 2004, hardly enough to bring the auto sector to its knees, let alone the rest of the economy with
it.
A shift in the composition of spending within the auto sector has also contributed to some of
the earlier recessions. If U.S. consumers suddenly buy fewer of the domestically produced gas
guzzlers and more of the fuel-efficient imports, domestic producers can be forced into layoffs.
But again, the shifts in the composition of spending underway right now have been much more
gradual. For example, sales of light trucks (which include the popular SUV’s) are down 2.8% in the
first five months of 2005, while sales of cars proper are up 1%. Domestic producer GM has taken a
somewhat bigger hit, with its light truck sales down 8%.
The U.S. economy certainly has the resilience to make gradual adjustments of this sort, which
of course are exactly what we need to do in order to respond to the reality that oil has become
more expensive to use. It is still possible that U.S. automakers will fumble this adjustment. The
weak financial status of the major airlines could also be a cause for concern about further
repercussions of high fuel costs. But, based on what is presently visible on the economic horizon,
my prediction is that this time we’ll manage to avoid this particular deja vu.
Detailed statistical analysis on which the above discussion is in part based is provided in my
paper “What Is An Oil Shock?”, published in the Journal of Econometrics in
2003.
Oil’s Rise Is Good News For The Economy
An article which discusses the difference between the current rise in oil prices and many which have preceded it. It even goes on to say oil’s rise is good. In each of the five biggest previous oil shocks, there was
One interesting data series you can find at the BEA is personal consumption expenditures on all energy. In nominal terms this increased from about 6% of total spending to 9% during the 1970s. But this cyclce this has only increased from about 4% to 5% of total spending. A lot of people quote the data on real energy spending as a share of real GDP to show the economy is less energy intensive now. But I think this series
shows it much better and provides a better comparison of the impact of higher energy prices then the widely used energy dependency ratio.
James Hamilton from UCSD Joins the Party…
He is incredibly smart and incredibly hard working: we eagerly look forward to lots of refreshments: Econbrowser: June 09, 2005 Oil futures and the future of oil Commodity traders can have as hard a time as any of us trying to predict oil prices. But i…
Alan Greenspan’s perceived increasing economic flexibility. I agree, though the foolishness of the American auto-makers in not haing planned new product properly is worrying. Consumers will do their best to maintain consumption pattersn and levels. Well, I like James Duesenberry.
I am pleased that I complained for you write cogently and compellingly.
Have you looked into the spot prices for natural gas and how they spike when supply threatens not to meet demand? We have an economic system with such deep dependencies on these fuels that I can’t imagine any kind of smooth transition. What do you think of the Department of Energy Sponsored report on the economic consequences of an oil peak?
Here’s the first paragraph:
“The peaking of world oil production presents the U.S. and the world with an unprecedented risk management problem. As peaking is approached, liquid fuel prices and price volatility will increase dramatically, and, without timely mitigation, the economic, social, and political costs will be unprecedented. Viable mitigation options exist on both the supply and demand sides, but to have substantial impact, they must be initiated more than a decade in advance of peaking.” http://www.energybulletin.net/4789.html
James Hamilton from UCSD Joins the Party…
He is incredibly smart and incredibly hard working: we eagerly look forward to lots of refreshments: Econbrowser: June 09, 2005 Oil futures and the future of oil Commodity traders can have as hard a time as any of us trying to predict oil prices. But i…
“If U.S. consumers suddenly buy fewer of the domestically produced gas guzzlers and more of the fuel-efficient imports, domestic producers can be forced into layoffs.”
The import domestic distinction is pretty close to meaningless. To be sure, Ford and GM still manufacture most of their trucks in the US, but some of them are made in Canada or Mexico.
However, so called imports such as Honda and Toyota now have major manufacturing operations in the US. Huyndai which is the fastest growing brand in the US just opened a plant here.
Ford and GM will continue to shrink, at least until they replace current managements with ones having a clue, but as they shrink their declines will have diminishing impacts on a growing economy and will be offset, at least to some extent, by the growth in manufacturing of so-called imports.
There seems to be no difference between our energy policy and the major oil companies’ prospectus. So I’m with Jason rather than James about our future management of a limited resource that screams out for more regulation and less manipulation.
Following spencer’s remark that the 70s saw a jump from 6 to 9% in terms of total spending (dramatically worse than the present 4 to 5% increase), do we need to look at deficit/GDP then and now, to see that we could afford that jump then, but perhaps not now? [How much more sophisticated are we now than in those 55mph days?]
I want to suggest that the oil industry is milking us, as opposed to OPEC in the 70s who were more politically and not entirely (accountant led) profit motivated.
Even if it should turn out that the milkers are just gentler, kinder, today than those barbarians 30yrs ago, it seems obvious that China’s (and India’s) emergence will mean significant more demand for the world’s dwindling supply of oil. It also seems obvious to me that the geopolitical climate in these circumstances is deteriorating and that future supply will be neither secure nor continuous.
Of course there is also climate change. How often will we be able to rebuild New Orleans and our refining capacity?