Rising oil costs: still nothing to worry about
I've written a couple of blog entries on oil prices. Since I commute via train from Westchester to Manhattan, I haven't been to the pump in two weeks. But even if I drove regularly, I wouldn't be worried about the overall American economy.
Nobody can afford "high-priced" gasoline?
What to do about the price of oil?
There is indeed a lot of market pessimism about both crude and gasoline supplies, and I expect prices to settle back down in a few months. Now, even at "catastrophic" prices, rationality will have to set in sometime. Speculators will eventually realize that they've pushed prices higher than what is worthwhile to them, and the market will correct itself naturally. It's very much a two-edged sword: those banking on higher oil prices, and so far successfully, have that much further to fall. Every generation seems to need such a lesson.
Chinese and Indian demand will keep prices higher for the foreseeable future, not likely at current levels, but higher than we were accustomed to until a couple of years ago. After all, China's demand for oil has doubled in the last decade. But the Chinese are very smart, investing in Albertan tar-sand operations as well as offering to buy PetroKazakhstan (Canadian-owned). I talked about that here (and why China looking out for its oil interests will benefit the United States).
The greatest panic would still not be a problem, because the price system will do what it's supposed to do: allocate oil and gasoline (or any resource) to whoever values them the most. Say that gasoline hit $4 per gallon, prompting me to cancel plans to drive upstate for the weekend. That means more diesel (since there will be more crude available to be refined into diesel instead of gasoline) is available for trucking companies who do value it at $4. Meanwhile the higher prices will encourage oil companies to find new sources of oil that were previously not feasible. Both will push prices back down to an equilibrium point. Now let's apply this to the global market for crude. "Lemming speculators" might be following the hype, and they might just be paying higher than they ought to. Nonetheless, they're willing to pay a premium to ensure their share of the market, and by definition they still can afford to pay the higher prices. It's not inherently a bad thing.
Americans have already been purchasing more fuel-efficient vehicles while cutting back on unnecessary driving, and they're even learning to slow down on the freeway (trading fuel for time). If oil got really high, more will start carpooling. So the price of gasoline may be increasing, but Americans are cutting back on their individual gasoline usage, so their individual fuel costs are increasing at a slower rate. Ah yes, let's not forget heating oil: many here in the northeast will keep the thermometer down a degree or two during the upcoming winter. They hope not to pay too much than before, which leaves more oil available for others who value it more. See how the price system forces conservation far more effectively than any legislation (let alone environmentalist campaign)? It's true you'll pay a higher price to use a scarce resource, but the point is that you won't run out of it.
Regarding the risk of a recession, that's extremely doubtful even at $70. Macroblog noted this April that one-third of economists in a summer 2004 WSJ survey thought the U.S. would suffer a recession if crude stayed between $50 to $59 per barrel. In the newest survey at the time, a total of 79% of surveyed economists said crude would have to sustain a value higher than $80 [to cause a recession]. But I question whether they've fully accounted for the incentive factor: again, if gasoline gets that high, people will cut back on their purchases of it, which will temper prices. After all, the old joke goes, "Economists have successfully forecasted ten of the last three recessions." Look to Paul Krugman as the ultimate false prophet of economic Armageddons.
It's not the end of the world (actually far from it) to spend a higher percentage of your income on fuel. It's a shift in spending, not a reduction. It might appear that you have less to spend on other things, but don't forget what happens to the dollars that oil companies receive: they circulate through the economy just like everything else. Even if it's oil company executives making millions, they either have to save or spend the money like everyone else. And oil companies and OPEC aren't fools, either. Like any good capitalist, they're already investing some of those profits in expanding oil production (which again means you might pay a higher price, but you'll have all the gasoline you want at that price). After all, they can't let prices get too high, because that makes substitutes too competitive.
Contrary to conventional wisdom, it's far preferable that oil companies make a killing than for government to institute price controls. High prices encourage production and are not as large a hit to GDP as price controls. Price controls, on the other hand, discourage oil companies from producing as much oil. If crude may sell for no higher than $40 per barrel, or gasoline no higher than $1.50 per gallon, then oil producers will produce sporadically, if at all, because there would be only so much oil and gasoline worth selling at those prices. That means people get thrown out of work.
What about OPEC getting all the money? Well, foreigners aren't just going to stuff dollars under a mattress. Dollars eventually come back to the U.S., either in outright spending or foreigners investing in U.S. assets. Much of the new luxury housing in New York City is going to foreigners who are paying cash. This means jobs for American construction workers and real estate brokers, so how is it a bad thing? My aunt and her friends in real estate never could figure out where the foreigners got the money, but it's simple. They earned a lot through the so-called "trade deficit" that we've had for years, whether with Japan, China or Saudi Arabia. So we haven't exported wealth at all; quite the contrary. The dollars come home in one way or another, whether foreign direct investment, foreigners buying U.S. and corporate bonds, and U.S. real estate.
While it's beyond the scope of discussing oil prices, some of you may be interested in my entry about foreigners buying housing.
The concerns about OPEC is an expansion of something Caroline Baum once wrote. This is a must-read article, where she explained why higher oil prices are not a tax.
Since oil is so widely used in the U.S. economy, it's said to have a "ripple effect" and cause the price of everything to go up. Well, the Fed can help cushion that impact by tighter monetary policy (additional interest rate increases and/or slower dollar creation). I have severe misgivings about central banking, but as long as we have the Fed, we do have the power to use monetarism. The danger is that the Fed does too much (by overestimating the impact of higher oil prices) and thereby causes deflation.
Bush's decision to loan out some of the Strategic Petroleum Reserve will help cool crude prices, but it will likely have less of an effect on gasoline prices. Remember that the current relative scarcity of gasoline (in strict economic terms it's not a shortage) was already as much, if not more, of a problem with refineries than with crude supply. Even then, leave it to the price system to settle things out.
Above all, keep a cool head and don't believe the false prophets who predict Armageddon year after year. Thou shalt not fear the economic girlie-men!