The confidence of US consumers shrivels after the last oil price shock

By Thomas Fischermann

[This article published in: DIE ZEIT 40/2005 is translated from the German on the World Wide Web,  http://zeus.zeit.de/text/2005/40/Argument_40.]

On first view, an all-clear signal seems appropriate. Hurricane Rita passed by with mild consequences on the pipelines, refineries, chemical plants and most oil production platforms in Texas. The future price for oil gives way. Over the weekend, George W. Bush’s chief economist Ben Bernanke hastened to report “relatively modest effects for American economic growth.”

Was the fear of the great oil shock wrong? Is America’s national economy still the economic locomotive of the world? Is it on a recovery course again after the ravages of Katrina?

Be careful! The oil prices in America and on the world markets are still unusually high. Despite the relief about Rita, a barrel cost over $60 at the start of the week. At $2.80, the price for a gallon of gas in the US is a third higher than last year.

Here is a mental experiment. Adjusted for inflation, the oil price today lies between the levels during the two great price shocks in the seventies. Converted to today’s prices, a barrel cost $37 after the 1973/74 Arab oil blockade and $88 after the price explosion provoked by the 1979/80 Iranian revolution. Is the next oil crisis coming now?

As a counter-question, what is an oil crisis? A lively debate has broken out in the last years over this definition. According to the classical version, oil shortages as in the seventies were suddenly triggers for rapidly rising oil prices that then caused the economy of importing countries to slacken. Although recessions actually followed these oil price jumps, the causal connection has been put in question since then. One time it simply took too long between cause and effect. Another time economic models could not explain why the oil price increases alone pulled down the economy. Why the lowest price for oil after 1986 did not cause a boom was a puzzle. Still today some economists make the reactions of central banks responsible for “oil crises,” not the oil price jumps. These banks raised interests out of fear of inflation.

In the meantime a majority opinion has formed among economists. “Oil crises” occurred when the price fluctuations were very powerful or very incalculable. However the greatest problem in the eyes of commentators seems to lie elsewhere when one follows the development in 2005. Before the disturbances through Katrina and Rita, most oil experts assumed that oil would remain expensive for years. Countries like China and India that for a long while consumed 15 percent of the world’s crude oil would need much greater quantities in the future. Instead of a brief shock on the oil market, a permanent crisis would be provoked.

According to usual estimates, the oil reserves of the world will last 40 to 70 years depending on how much easily producible oil is found, how many cars are driven in China and India and how quick is the technical progress in developing alternative energies or in producing oil from oil shale. The international Monetary Fund expects that the shortages will be felt in constantly increasing prices in the next decade – and that the price of oil in 2030 will be between $39 and $56.

That would certainly be lower than today. A closer view reveals that the scenario of constantly rising oil prices will not alarm America or the world economy. Firstly, it would reflect a healthy demand development in China, which would be better than the much-quoted possibility of a crash of the Chinese economy. Secondly, constant price increases will probably cause free market adjustment processes, more investments in exploitation and greater competitiveness of alternative energies. On top of that, the tapping of largely undiscovered sources of energy will reward efficiency. Finally, the extreme gas thirst of cars today is an essential reason for the high oil consumption.

However there is another scenario for an “oil crisis” in America that would be similar to past experiences: a sudden price jump on the oil markets in an unstable environment could accelerate the loss of trust in the American economy.

Back to the hurricanes. Meteorologists warn that more cyclones could follow allied with more nasty psychological blows. The winter approaches. American households must buy their heating oil for the first time at the new higher prices. The hesitant reaction of the Bush administration to the flooding of New Orleans has shattered American self-assurance. In Washington, reconstruction costs are estimated in the three-digit billions fomenting the fear of higher state debts. The news from Iraq is bad.

The trust of American consumers in the economic future has already suffered greatly. This trust has hit its lowest level since 1992. Americans expect less growth and more inflation. Therefore the alarm bells sound among economic observers because the US economy for years has lived from households accepting more and more debts and buying vigorously in belief in a rosy future. Enormous economic imbalances have been created, a negative saving rate and a balance of payments deficit soaring to seven percent of the total economic power. The shopping rage of American consumers has kept the world economy going up to now.

Meteorologists may have granted a pause after Katrina and Rita. The economic watchmen should remain at their posts.