Re: oil and the new economy

[Louis Proyect <lnp3@xxxxxxxxx>]

>What has happened to the claim that the New Economy is no longer very
>sensitive to oil prices?
>
>--
>Michael Perelman
>Economics Department
>California State University
>Chico, CA 95929
>
>Tel. 530-898-5321
>E-Mail michael@xxxxxxxxxxxxxxxxx

The Guardian (London), September 13, 2000

Fuel crisis: How old tech oil put skids under new economy: Economics:
Recession rather than inflation the biggest threat

Larry Elliott Economics editor

As the queues formed outside the few remaining petrol stations open for
business yesterday and panic buying for food began, economists who have
pioneered the view that the world has become a virtual marketplace in which
energy no longer matters were left scratching their heads.

Britain - after just two days of protest - had moved from a country in
which the government talked about the benefits of a "new economy" to one in
which emergency powers were being invoked to deal with a crisis caused by
the oldest of old technologies - a shortage of fuel.

It is not just in Britain that governments are concerned about the
possibility of the old economy biting back. President Bill Clinton has
warned the oil producers' cartel, Opec, that it could plunge the global
economy into recession unless it produces more oil, and the US government
is considering whether to release oil from its strategic petroleum reserve
to increase supplies and lower prices.

Professor Andrew Oswald, of Warwick University, is one of those who believe
that the significance of the new economy has been overstated. He argues
that the three previous sharp increases in the price of crude since 1973
have all led to recessions and that the fourth - the fourfold increase
since the beginning of last year - will have the same impact. Prof Oswald
rejects the idea that the computer chip and the mobile phone are the
visible signs of a "weightless" world not vulnerable to energy shocks.

"Oil is an important input. Most especially, its price influences the
prices of other energy sources, and so, in turn, determines lots of other
infuential prices in the economy. (And) employment and output respond."

Economic historians now believe that the low level of oil prices in the
three decades after the second world war helped to create the conditions
for the long burst of economic growth from 1945 to 1973, and that the price
collapse in the aftermath of the 1991 Gulf war has been equally important
to the success of the US economy. Cheap energy has pushed down inflation,
allowing the Federal Reserve, America's central bank, to foster growth by
keeping interest rates low.

The key question now is what happens next? In theory, all three of the
world's major economic blocs are vulnerable. Japan, which is only just
emerging from recession, is highly exposed to higher oil prices, the
combination of more expensive energy and the declining euro has already
pushed inflation in the single-currency zone above 2% and triggered an
increase in interest rates from the European Central Bank, while the boost
to corporate profits from cheap oil, which has been a crucial factor in
underpinning share prices on Wall Street, could quickly evaporate.

According to figures due to be released by the International Monetary Fund
next week, 2000 will be the best year for the overall global economy in a
decade.

But already there have been signs of a slowdown prompted by the rise in the
cost of a barrel of crude oil from under Dollars 10 in early 1999 to around
Dollars 35 last night.

Economists see recession - rather than a burst of 70s-style high inflation
- as the big threat. Graham Turner, of consultancy firm, GFC Economics,
said that the real problem with oil was not the increase in demand but
supply-side factors specific to the oil market.

"Although the global economy has staged an impressive comeback since the
economic crisis of 1997-98, the failure of non-energy prices to stage a
more meaningful recovery suggests that high oil prices are not a reflection
of a wider global imbalance between supply and demand.

"Supply restrictions certainly played a key role in lifting prices from the
lows experienced at the end of 1998, but in recent months speculative
forces appear to have taken on a greater significance."

Mr Turner added that the slowdown in the global economy caused by higher
oil prices would eventually lead to the pricking of the speculative bubble,
which in turn would bring prices down again.

Analysts believe that the impact of dearer fuel is being felt by both
consumers and businesses. Consumers' living standards are affected directly
by the extra expense involved in filling up their cars with fuel or by the
higher cost of public transport, while the ultra-competitive global market
has meant that businesses are finding it hard to pass on the full cost of
the rise in the cost of energy to their customers.

Mike Lenhoff, of City firm Capel Cure Sharp, said that growth in real
(inflation-adjusted) wages in the UK was lower now than it was at the start
of 1999. "The bottom line is that higher oil prices have already done much
to squeeze real income growth."

The scale of the slowdown depends on how policymakers react. In the short
term, dearer oil will push up inflation but it is the medium and long-term
effects that really count. If politicians and central bankers conclude that
the result of higher energy prices will lead to knock-on effects, with
workers able to secure higher pay to compensate for the reduction in their
living standards, then the result will be higher interest rates and an
increased chance of a hard landing.

However, if there are no so-called second round effects, policymakers will
assume that the spike in inflation caused by the dearer crude oil will
unwind as the economy slows and oil prices start to subside. The next few
months will prove vital.


Louis Proyect

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