About $52.50 now, after hitting $53
Is oil strike three for the U.S. economy?
With the tax cuts losing their punch and home equity tapped out, oil at $50 may be a blow the economy just can't shake off.
By Dan Ackman, Forbes
Leave it to America's allies in Saudi Arabia. With oil prices nearly twice as high as they were a year ago, the kingdom has announced it will sell more of its inventory and pretends it is doing its customers a favor.
"The kingdom is also ready and capable of making up for production shortfall occurring anywhere in the world," Saudi oil minister Ali al-Nuaimi said. And at $50 per barrel, why not?
As oil prices continue to rise, U.S. gasoline prices are increasing in response, and economists are starting to take notice. For now, few are predicting a return to recession, despite the fact that oil price spikes in 1981, 1990 and 2000 all tugged recessions in their wake. After years of ignoring inflation in reporting "record" oil prices, now most reports can't talk about it enough, pointing out that oil prices are still not at the inflation-adjusted levels of 1981. Check out your options.
But oil prices are today much higher -- even adjusted for inflation -- than they were in 1990 and 2000. And compared to earlier decades, a greater percentage of U.S. oil is imported, so more of the price hike flows overseas.
Less room for maneuvering
Still, according to an interesting report from Goldman Sachs (GS, news, msgs), oil, even with the price surge, is not the biggest macroeconomic problem for the U.S. right now. Bigger problems: the loss of tax stimulus and "the waning of mortgage equity withdrawal." Goldman economists said they are not changing their forecast for U.S. gross domestic product growth, which they project at 3.5% for the second half of 2004, but they are starting to rethink and may rethink even harder if oil prices do not fall back to $36 per barrel, as Goldman expects they will.
Of greater concern, they said, is that household finances are stretched after a wave of home mortgage refinancing (including trade-ups to larger homes with less equity in the second home). Also troubling is the loss of tax stimulus to the economy as some tax cuts garnered by consumers in the last two years will end this year. Those two factors could put a damper on consumer spending, which is 70% of GDP. Both have had a greater effect than the rise in oil prices, Goldman said.
The effect of home refinancing is huge. A Goldman economist, Andrew Tilton, said that in 2003, refinancing added $550 billion to household cash flows. That's not income; it's a reduction in equity. But the refinancing did put a tremendous amount of cash in consumer's pockets, and they tended to spend a lot of it. In 2004, the cash flow from refinancing is likely to fall by $50 billion to $100 billion, Tilton said.
Changes in tax policy are also likely having a significant impact on GDP. The Bush administration tax cuts, along with much lower interest rates, have stimulated spending in the last two years. But taxes are likely to remain stable for the time being, so the stimulant effect is gone, Goldman said. All told, Goldman expects a "sluggish trend" of about 2.5% growth for several years.
A spike that's beginning to look permanent
Like most economists, Goldman sees $50 for a barrel of oil as a price "spike." Its GDP forecasts assume oil prices will settle back to $36. Recently there has been political turmoil in oil-producing nations like Russia, Venezuela, Nigeria, Iraq and even Saudi Arabia. Just last month U.S. Treasury Secretary John Snow said, "I think there's a recognition that this $50 price is the result of an anomalous set of circumstances" resulting in part from the current "geopolitics of oil."
But while political trends shift on a dime -- including for the worse -- at least part of the rise in oil prices looks to be from "permanent" factors like increasing demand from China and India. Goldman notes that five-year forward oil future contracts were selling at $35 per barrel (as of a month ago). Two years ago, the price was around $20. Meanwhile, oil stocks like Exxon Mobil (XOM, news, msgs), BP (BP, news, msgs), ChevronTexaco (CVX, news, msgs), Halliburton (HAL, news, msgs) and Schlumberger (SLB, news, msgs) -- all sharply up in the past year -- continue to rise.
Oil prices, it seems, have broken out of a long-term trend. In recent years, consumers might have shrugged off that increase as they pocketed cash from tax cuts and refinancing. Those cushions, like politics, are also not permanent.
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