Sunday, December 6, 2015

Oil: The Cheaper, The Better The Economy

(Drivebycuriosity) - If we believe the media then the falling oil prices are bad for the economy, or even worse, they are a sign of global doom. There is a deluge of pessimist headlines related to cheap oil. But they all give a wrong picture of the economic reality. The claim that "cheap oil" is bad, is quite nonsense. History shows quite the opposite: The cheaper oil gets, the better the economy. To illustrate this I display below 4 historical charts.

The chart above shows that oil price jumps were followed by recessions (wordpress). The chart also shows that periods with low oil prices were accompanied with periods of economic prosperity.

Here`s another chart with the same message (oil): Spiking oil prices in 1973, 1980, 1991, 2001 and 2007 contributed to a greater or lesser degree to the  economic recessions of 1973-4, 1980-81, 1991-92, 2001-2003 and 2007-08 (forbes).

In the early 1970s the oil price jumped because OPEC cut production sharply. The explosion of the energy costs lead to two recessions and decade of stagnation. In the first half of the 1980s the oil price collapsed because Saudi Arabia flooded the markets - as they do today (wsj this link has a paywall.You can bypass by copying the link into google). This induced a period of cheap oil and other commodities till around 2003. Cheap commodities in combination with falling interest rates and a technological revolution (Internet) lead then to a period of prosperity (with the exception of 1992 as the first Iraq war caused an oil price spike which caused  a mild and short-lived recession), the longest boom in U.S. history (factcheck).

In the year 2003 the price of oil started to climb again because of the Iraq war, other conflicts in Middle East and a massive financial speculation in commodities (driveby). The price of oil peaked at $146 in summer 2008, followed by a sharp recession (econbrowser). The high oil prices from 2009 through 2014 (above $110) were accompanied by a sluggish economy (maybe the massive QE programs averted another recession).

Below to more charts for those who still disbelieve (blogspot content):


The current oil price drop works like a global tax cut. Consumers world wide have more money to spend for other goods & services. Dropping energy prices translate into lower transport costs - thanks to cheaper Diesel - which lead to lower prices for food and other goods. Cheaper energy alsos reduces the costs to produce steel, cement and many other energy intense goods. Many things which are made from oil, like cleaning fluids, laundry detergents, paint, pharmaceuticals, cosmetics, hygiene products, diapers & plastics, also get cheaper. So, cheap oil translates into low inflation which allows low interest rates.

The current oil flood and the return of cheaper oil reminds of the mid 1980s, which was the begin of an epoch of economic prosperity with low inflation & interest rates. I believe that the current oil flood will continue thanks to the technological progress which raises efficiency and reduces cost of oil production. Cheap and abundant oil will fuel another period of global economic growth. Enjoy. 

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