Why oil shocks just aren't so shocking
By Barrie McKenna Globe and Mail | March 17, 2005 http://www.theglobeandmail.com/servlet/story/RTGAM.20050317.woily0317/BNStory/Business/ The economy of 2005 isn't the economy you grew up with, when oil shocks would spark runaway inflation and plunge mighty countries into recession. Think 1974 or 1981. According to a draft version of the International Monetary Fund's latest World Economic Outlook, not even oil at $80 (U.S) a barrel would sink the global economy. There would be negative effects, for sure, as higher transportation and energy costs filtered through the system. But the IMF argues the world could probably cope with oil prices much higher than they are now. The reasons for the transformation are complex, and not yet fully understood by many economists. But perhaps the most basic change in the global economy in the three decades since the first major global oil shock is that neither consumers, businesses nor investors expect to be paying more for stuff - other than gasoline - in the months ahead. There is also widespread confidence that the U.S. Federal Reserve Board and other central banks have a firm grip on inflation, and won't let volatility in crude prices alone drive monetary policy. That partly explains why long-term interest rates in the United States have continued to fall, even as the Fed has raised short-term rates. There is a more basic explanation for oil's muted effect. Energy simply doesn't take as big a bite out of what consumers and businesses spend as it once did. For example, energy accounts for 7 per cent of gross domestic product in the United States today, versus 14 per cent in 1981. Adjusted for inflation, the price of oil was the equivalent of more than $73 a barrel in 1981, or nearly $20 higher than today's levels. Consumers are also less likely to feel the impact. Energy costs take 5 per cent of U.S. consumers' disposable income today, against 8 per cent in 1981. While crude prices are up more than 45 per cent in the past year, the relative impact on most consumers and businesses is small. Rock bottom interest rates and rising incomes mean that Americans may cringe when gasoline is at $2 a gallon, but most haven't yet adjusted their behaviour by driving less or buying smaller cars. "We're in a credit boom so everyone thinks they can spend more, even though their incomes are not rising that much," said Ted Breton, director of energy market forecasting at Pace Global Energy Services in Fairfax, Va. "A very large percentage of people in the United States think they are wealthier because the value of their house has gone up so much." It may not be sustainable, but consumers are borrowing heavily off their inflated home prices to sustain their lifestyles, he said. That explains why many retail businesses report that rising fuel prices haven't yet put a dent in sales. Wendy's International Inc., the No. 3 U.S. fast-food chain and parent of Tim Horton's, reported this week that it has seen no impact of higher gas prices. Other normally oil-price-sensitive industries, such as airlines, have also been an anomaly. Competition among airlines remains intense because so many carriers are continuing to operate while in bankruptcy protection, badly distorting industry economics. Airlines are finding it tough to pass along higher jet fuel prices to consumers. U.S. farmers have complained that higher natural gas prices are driving up the price of fertilizer, costing them an extra $6-billion (U.S.) over the past two years. But that has also coincided with strong global prices for farm products. Even manufacturers generally aren't passing along higher energy prices to their customers, argued Michael Helmer, an economist at Economy.com in West Chester, Pa. "Even now, price increases in some industries are muted or non-existent," he said. So even though energy prices have risen, they account for a relatively small share of most businesses' overall costs, compared with 20 years ago. U.S. government statistics indicate that energy accounted for an average of just 3 per cent of manufacturers' costs between 1997 and 2001. They spend way more on labour (39 per cent), non-energy inputs (24 per cent) capital (19 per cent) and business services (14 per cent). "This helps explain why the economy has managed to move forward in recent months ... despite historically high fuel costs," Mr. Helmer said. ------------------------ Yahoo! Groups Sponsor --------------------~--> What would our lives be like without music, dance, and theater? 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