Economics: Is Oil Eating The Economy?

(Drivebycuriosity) - Yesterday we learned that salaries in the US climbed 2.8%. Unfortunately the US inflation rate is 2.7%. So, inflation is eating most of the salary gains. Inflation is driven by climbing oil prices, rents & health costs. Brent Crude, the gauge for the global oil market, jumped 51% in the recent 12 months and the rising oil price translates into climbing cost for gasoline (plus 16% aaa.com).

Rising expenses for energy are sucking billions of Dollars out of the economy and are slowing economic growth. Consumers, who have to spend more on the gas pumps, have less money for other goods & services. Climbing cost for transportation are raising the cost of almost everything you can find in a shop, pushing even the core inflation (excluding food and energy) higher and reducing consumer spending, the engine of the economy, further.




                                             Beware Of The Snowball Effect

It could get worse if the oil rally continues. The recent oil price rally is driven by speculation. Hedge funds and other speculators are betting on oil supply disruptions thanks to the Iran sanctions, the crisis in Venezuela and other issues. There is the risk that the oil price rally gets out of control - as in 2007/2008 when the price of oil trippled. Rising oil prices attract more speculative buyers - the momentum players - who are betting on further price gains. This herd behavior is driving prices even higher - a self-fulfilling prophecy. The process can escalate and create a snow ball effect - rising oil prices cause further price rises - till the system implodes.

Unfortunately the US economy responds very sensitive to oil price jumps. Nine out of ten of the U.S. recessions since World War II were preceded by a spike up in oil prices, writes Prof. James D. Hamilton, University of California, San Diego ( pdf econweb). Another study by Prof.  Hamilton shows that the oil price shock from 2008 - from summer 2007 through July 2008 the oil price spiraled from about $50 to $147 -  turned the economic slowdown into a severe recession (econbrowser).: "The oil price increase over 2007:H2-2008:H1 should be regarded as a key development that turned the slowdown in growth into a recession" (archives).

Other researchers came to the same results: "Oil prices played a role in eventually bursting the US subprime bubble....In 2003, the average suburban household spent $1,422 a year on gasoline, which rose to $3,196 in 2008 (oilprice). "Rising household energy prices constrained household budgets and increased mortgage delinquency rates" (oilprice). Low income suburban homeowners suffered most from the rising gas prices.  Poor homeowners are called "subprime" and their delinquencies are known as "subprime crisis."

But there is also hope. Fortunately the US oil production is rising  - thanks to fracking. Climbing oil prices make more oil wells profitable - and also more offshore drilling -  which could lead to an over-supply of oil and the bubble may pop again - as it did in 2014. Time will tell.