The conventional wisdom has it that the recession is the result of the toxic loans which caused the credit crisis leaking into the rest of the economy. As a story it’s always had a bit of a hole in it for me; the length of time between ‘debtonation day‘ in August 2007, when the banks stopped lending to each other, and the start of the recession a year later. The economist Jeff Rubin has suggested that the recession was caused instead by the high oil prices earlier this year.
A post in the Oil Drum summarises the argument like this:
These higher oil prices caused Japan and the Eurozone to enter into a recession even before the most recent financial problems hit. Higher oil prices started four of the last five world recessions; we shouldn’t be too surprised if they started this one also… Rubin observes that it isn’t surprising that Eurozone and Japan entered into recession before the United States did. The United States is less sensitive to oil price spikes because it is itself an oil producer (5 million barrels out of 19 million barrels the US consumes are produced in the US), so it receives some of the benefit of the higher prices.
One of the relevant factors is just the comparative scale of the flows of funds in the oil spike is much larger than the deflation caused by the property market. “Over the last five years their annual fuel bill has grown a staggering $700 billion. Of this, $400 billion annually has gone to OPEC producers.” One of the reasons that this leads to slump is because it’s not neutral: money is transferred from economies with low savings rates (where it gets spent) to economies with high savings rates (where it doesn’t).
From Rubin’s perspective, of course, this could be regarded as good news, since it might support those who believe that we’re more likely to see a short sharp recession.
Some of the best research indicates that it takes about a year for an oil price shock to have its maximum impact on US GDP. Leading macro and energy economist James Hamilton notes these lags fit the experience of past shocks, including the OPEC-induced recessions of the 1970s. … It has also been found that a similar lag structure holds for the impact of large declines in oil prices. … the impact from the even larger decline in oil prices over the last two quarters should give its maximum boost to the economy moving into 2009.
I’m persuaded by quite a lot of this: I think the attention paid to the credit crisis is a classic example of cognitive bias (dramatic events are amplified by the politics and media, and and causality ascribed as a result).
But at the same time, it’s also clear that the credit crisis has compounded the problems caused by oil-price recession. All recessions have their own characteristics, and in this case the notion of a credit crisis which developed largely independently of energy costs is a point of difference. The recession in the financial services sector is disproportionate as a result, and the fragility of the banks’ balance sheets means that they are less likely to extend credit lines, or to roll over existing loans as they reach the end of their terms – even if their state shareholders think they ought to be.
And related to this – in the US and the UK – is the extend to which consumers have reached the limits of their ability to absorb debt. Consumer-driven growth – or consumer-driven recovery – needs consumers with disposable income to dispose of. The fall in oil prices helps take some of this pressure off household budgets – as long as companies pass it on rather than using it to rebuild their balance sheets.
the next wave
I like this theory but the issue for me is the description that it is a ‘spike’. Superficially it is, however, it seems to me at least to be the first pre-tremors of ‘Peak Oil’, i.e. the start of an inevitable and permanent climb in oil prices – with the long-term impact on the world economy. I also agree with your point that the recession is being driven by huge debt, especially in the UK and US where house prices have fueled a false sense of security, supporting increases in debt. The next few months should see the ‘second wave’ of bank problems as these organisations really start to get the measure of their exposure.
Good blog.
Well, it’s a spike at the moment! I share your view that increasing volatility is a sign of approaching Peak Oil, and that the upward trend line is going to be upwards – a point of view which even the International Energy Agency has come round to in its most recent report. I’ve also been reading some stuff lately that connects the oil and food price spiral last year to hot speculative money looking for a home outside of the banking sector, which also has a ring of truth about it.
But as I write in my post about longer-term futures (18th January), there’s a wider question about whether the globalising expansion of the last 25 years was a blip or a trend. I think it was a blip; the last long fling of cheap energy, propped up by cheap money.
I believe there is something to this argument. Unfortunately, I therefore think the US government is treating symptoms instead of accurately diagnosing the problem. If the economy is truly suffering as a result of the average consumer reducing their spending levels, then its very unlikely that the consumer was somehow knowledgeable of the complex trading instruments, credit swaps, mortgage backed securities in a way that created a mass reduction in spending. No, the easiest answer fits, consumers saw a years long trend in oil prices that was impacting whether they could live or not. When we were flirting with 5$/gallon gasoline I actually heard a woman in line at a grocery store explain to her friend that she’s not sure what she’s going to do if gas keeps going up and that she just wouldn’t be able to drive. It was likely more than just her, but at that level the economy is not sustaining itself but is screeching to a stop.
No, I’m not going to push the ‘Peak Oil’ theory because while in theory I agree, I do not agree with the notion that every uptick in prices is a sign that ‘Peak Oil’ is here. That is simply rubbish. This was/is a market economy driven by a lot more factors than just whether there is oil or whether there isn’t. I think the $150/barrel train’s wheels were greased a bit too well by Bill Clinton in the CFMA of 2000 bill. Peak oil will probably happen or may be slowly happening, but what we had was more of a gold rush as so many huge financials viewed it(investment banks, sovereign wealth funds, universities, hedge funds etc.). Those that speak towards Peak Oil are blindly pointing to the price increase as evidence in and of itself.
The problem is pretty obvious, we just ‘stress-tested’ the economy with $5 gasoline and we failed. Things start shutting down at $150/barrel, those who claim we’ll get to $200 are either financially secure/insulated from whats happening and will wonder why they can’t gas up their car a week after the profit for such a business has dried up once nobody can afford it, or are fully equipped with the means and knowledge of how to drive the market there…
If you want to restore consumer confidence, you need to show that the next time prices go up, it won’t be because of greed. The drop in oil has thrown everybody off track, but the problem still exists. We need enforceable regulation, transparent markets so that we can actually see who has positions in oil so that in case there is manipulation we could do something about it.