FYI | Nov 04 2008
By Chris Shaw
It is easy to blame the credit crisis and the chaos it has brought to financial markets for many of the current ills affecting the global economy, but as CIBC World Markets suggests, the timing and size of the downturn means there are likely to be other factors that are more responsible for the current state of affairs.
In the group’s view, the economic cost of the recent run up in oil prices to almost US$150 per barrel is just a significant a factor. The group suggests the economic cost of the increase was far more significant than the impact of falling house prices on housing starts and construction jobs, which seems a more obvious factor in the slowing of the economy in that it stems directly from the collapse of the US housing sector.
The other significant factor to note from the oil price surge is its cost was felt directly on Main Street, USA rather than on Wall Street, as consumers directly suffered from reduced spending power as the higher oil price acted as an increase in tax and reduced the disposable portion of household budgets.
As CIBC notes, oil price shocks and recessions are no strangers, with four of the last five global recessions having been preceded by substantial increases in oil prices. The group points out the increase in real oil prices this time was more than twice the move that occurred in either the first or the second OPEC oil shock, which were largely responsible for two of the world’s deepest post-war recessions.
Previous oil price shocks have set off recessions by transferring billions of dollars of income from OECD countries to OPEC countries, where savings rates tend to be very high. This means much of the money transferred never gets spent as more and more of the world’s income is saved and less and less remains in circulation, which means lower demand and so causes a weaker global economy.
This is exactly what has transpired this time around, though as CIBC notes, while oil was well above US$100 per barrel this time the size of the transfers were much larger. On the group’s estimates, the US’s annual oil price bill has risen by US$200 billion since 2005, an amount larger than the recent fiscal stimulus package.
Add in the fact it isn’t just the US, but most other nations as well that have had to foot higher fuel bills and CIBC estimates over the past five years the annual cost of fuel for the OCED nations as a whole has increased by US$700 billion, with US$400 billion of this going to the OPEC producers.
Supporting the group’s view that it was oil prices and not the financial and housing crisis that sparked the recession is the fact the oil price shock fits in better with the timing of the economic downturn. If the credit crunch was responsible it would have been reasonable to expect the European and Japanese economies to turn down as LIBOR rates soared on the back of the crisis, but they had already begun weakening before this occurred.
As well, CIBC points out both Japan and Europe are more susceptible to rising oil prices as the US is also an oil producer and so that portion of its economy gets a boost from higher prices. Japan must import all of its oil and this impacts across the entire economy. It is largely the same situation for Europe.
Back in the US, the rise in the oil price not only brought down household spending by the largest quarterly fall in this measure in 25 years, but the country has also seen a reduction in both auto sales and miles driven. CIBC estimates 80% of US GDP shows a strong negative correlation to high energy costs, as high oil prices impact on other sectors such as travel and agriculture as well.
Given some research shows it can take up to a year for the full impact of an oil price shock to flow through into the broader economy, CIBC cautions the maximum impact is probably being felt right around now, as it was the third quarter of 2007 in which the oil price really started to move higher.
The same time lag tends to apply on the downside as well, so while a recovery in the global economy will require weaker oil prices, and this has happened in the past couple of months as the oil price has more than halved to close to US$60 per barrel, CIBC estimates it may not be until 2009 that the economy receives the maximum boost from the falls.
In other words, if the oil price shock was what really caused the current economic downturn then prices at US$65 per barrel mean the global economy is well on the way to recovery, but as the group notes, it will be some time before this recovery really picks up steam.
