The Biggest Threat to the Global Economy



POSTED BY Ed (29 days ago)
Why oil prices can’t rise very high, for very long

Oil prices are now as high as they have been for three years. At this writing, Brent is $74.14 per barrel and West Texas Intermediate is at $68.76. These prices aren’t really very high, if a person looks at the situation from a longer term point of view than the last three years.

There is always a question of how high oil prices can go, and for how long.

In fact, we have many resources, of many kinds, whose prices of extraction keep rising higher. For example, obtaining fresh water for the world’s population keeps getting more and more expensive. Some parts of the world need to resort to desalination.

The world economy cannot withstand high prices for any of these resources for very long. Certainly, it cannot withstand high prices for a combination of necessary resources, because people need to cut back on other purchases, in order to afford the necessities whose prices are rising.

This article is a guest post by another actuary, who goes by the pseudonym Shunyata. He explains in a different way why high resource prices cannot last, whether they are for oil, or natural gas, water, or even fresh air.


Ed (29 days ago)
What are the possible causes and consequences of higher oil prices on the overall economy?

As a consumer, you may already understand the microeconomic implications of higher oil prices. When observing higher oil prices, most of us are likely to think about the price of gasoline as well, since gasoline purchases are necessary for most households.

When gasoline prices increase, a larger share of households’ budgets is likely to be spent on it, which leaves less to spend on other goods and services. The same goes for businesses whose goods must be shipped from place to place or that use fuel as a major input (such as the airline industry). Higher oil prices tend to make production more expensive for businesses, just as they make it more expensive for households to do the things they normally do.

It turns out that oil and gasoline prices are indeed very closely related. Figure 3 plots average monthly oil prices from 1990 through early 2008, using the spot oil price for West Texas intermediate (right scale, thin blue line, measured in dollars per barrel) and the U.S. retail gasoline price (left scale, thick red line, measured in cents per gallon).

The two series track each other very closely over time: increases in oil prices are accompanied by increases in gasoline prices. As shown in the graph, the correlation coefficient (denoted “r”) for the two series is 0.98. Moreover, the monthly changes in oil prices and gasoline prices (not shown) also are very highly and positively correlated.

I’ve just explained how oil prices affect households and businesses; it is not a far leap to understand how oil prices affect the macroeconomy. Oil price increases are generally thought to increase inflation and reduce economic growth. In terms of inflation, oil prices directly affect the prices of goods made with petroleum products.

As mentioned above, oil prices indirectly affect costs such as transportation, manufacturing, and heating. The increase in these costs can in turn affect the prices of a variety of goods and services, as producers may pass production costs on to consumers. The extent to which oil price increases lead to consumption price increases depends on how important oil is for the production of a given type of good or service.

Oil price increases can also stifle the growth of the economy through their effect on the supply and demand for goods other than oil. Increases in oil prices can depress the supply of other goods because they increase the costs of producing them. In economics terminology, high oil prices can shift up the supply curve for the goods and services for which oil is an input.

High oil prices also can reduce demand for other goods because they reduce wealth, as well as induce uncertainty about the future (Sill 2007). One way to analyze the effects of higher oil prices is to think about the higher prices as a tax on consumers (Fernald and Trehan 2005).

The simplest example occurs in the case of imported oil. The extra payment that U.S. consumers make to foreign oil producers can now no longer be spent on other kinds of consumption goods.3

Despite these effects on supply and demand, the correlation between oil price increases and economic downturns in the U.S. is not perfect. Not every sizeable oil price increase has been followed by a recession. However, five of the last seven U.S. recessions were preceded by considerable increases in oil prices (Sill 2007).4


Ed (11 days ago)
And here we can see... in very stark terms... the impact of higher oil prices:

Even though the average wages of an American increased 21% since 2009, the median new home price is 60% higher. Part of the reason for the higher new home price is demand but also is the higher cost. For example, the lumber price shut up 170% since the beginning of 2016. When the U.S. median new home price reached a high of $262,000 in 2006, the price of lumber was $330. Today, the lumber price isn’t quite double, but at $592, it’s pretty darn close:

You will also notice that the lumber price fell in mid-2014 to a low of $220 at the beginning of 2016. The falling lumber price was party due to the falling oil price. One of the significant costs for cutting and transporting lumber is energy. As the oil price fell in half by 2016, it impacted the price of lumber. However, the lumber price has increased a great deal more in percentage terms than the oil price and seems to be in a bubble or huge top formation.

Ed (11 days ago)
What would happen to the U.S. economy if petroleum prices continue their rapid rise?

University of California, San Diego, economist James Hamilton noted in a recent study that 10 out of 11 post-World War II recessions [PDF] in the United States were preceded by a sharp increase in the price of crude petroleum. The only exception was the mild recession of 1960-61 for which there was no preceding rise in oil prices.

Hamilton has also written a fascinating short history [PDF] of U.S. and global oil price shocks. Until 1974 the United States was both the world’s biggest consumer and producer of crude oil. Although domestic oil production has recently upticked, the U.S. today produces about half the oil it did in 1971. It still is the biggest consumer.

It turns out that boom/bust price shocks have been a feature of oil production ever since Edwin Drake drilled his first well in Pennsylvania in 1859. Before Drake’s well crude oil was being sold for the equivalent of $2,000 per barrel (2009 dollars). After Drake’s discovery, the price of oil collapsed by 1861 to about $2.50 per barrel.

In those days, the products of crude oil chiefly competed against ethanol as illuminants. Oil became increasingly important to the U.S. economy as it took over as the chief transport fuel. In 1900, there were 0.1 internal combustion-engine vehicles per 1,000 residents, rising to 87 by 1920, and reaching 816 in 2008.


Ed (9 days ago)
Oil prices: How high before Wall Street freaks out?

History shows that when crude spikes by more than 80% in a year, it can pose serious problems, according to Brad McMillan, chief investment officer for Commonwealth Financial Network. Crude was fetching about $47 a barrel a year ago. That suggests the price to watch is about $85 a barrel. That’s roughly 19% above current levels.

Ed (8 days ago)
Gas Is Headed for $3 per gallon. What that means for the US economy

Morgan Stanley estimates that if gas averages $2.96 this year, it would take an annualized $38 billion from spending elsewhere, an upward revision from the bank’s $20 billion estimate in January. That would wipe out about a third of the additional take-home pay coming from tax cuts this year, the analysts said.

Airlines and shipping companies will also be paying more for jet fuel and diesel—costs that may be passed along to consumers. Even companies such as Whirlpool Corp. have noted that higher oil prices have boosted the cost of materials.

Ed (4 days ago)
As oil rises, warnings emerge from U.S. retailers

Worries about rising oil prices have begun to creep into U.S. retailers’ earnings calls, and investors are raising concerns that those costs may slow discretionary spending among Americans and push down the performance of the retailers’ shares.

Walmart and Home Depot Inc also have pointed to increased transportation costs stemming from more expensive fuel and a shortage of drivers, factors that have put pressure on their margins. Walmart’s lower margins sent its shares falling 1.9 percent on Thursday.

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