by Allison A. Bailes III, PhD
True or false: The collapse in the housing market because of problematic mortgage products caused the meltdown on Wall Street and sent the global economy into a tailspin? If you answered true, you can hardly be blamed because that’s the message of most of the news and analysis I’ve seen about the current state of the economy.
For the real reason, however, we must look at another big story in the news for the past three years, one that’s run parallel to the big economic news of late but that few have seen fit to connect causally with the downturn. I’m talking about the tremendous spike in the price of oil.
Jeffrey Rubin, an economist with CIBC World Markets, correctly places the blame for the recession on oil prices. As he says in CIBC’s October 31st newsletter, “Oil shocks create global recessions by transferring billions of dollars of income from economies where consumers spend every cent they have, and then some, to economies that sport the highest savings rates in the world.”
Let’s look at some of the evidence. First, four of the past five recessions came after oil price spikes: The 1973 oil embargo, the Iranian revolution, the first Iraq war, and the minor recession of 2000-01. Further, the price spikes in those cases were in the range of 100 to 200%. The run-up in oil prices over the past few years is about 500%.
As Rubin says in the above quote, these higher prices have resulted in a massive transfer of wealth consumer economies to producer economies. Over the past five years, member countries of the Organization for Economic Cooperation and Development have seen their fuel bills rise $700 billion.
That may not seem like much money when we now have a US bailout plan that measures in the trillions, but remember that much of that rise in fuel costs is paid by you and me, not by Wall Street or the federal government. When that money leaves our pockets to pay higher fuel bills, we either cut back somewhere else or go into debt to keep our spending up.
Second, timing is a problem with the housing market hypothesis because the economies of Europe and Japan tanked before the meltdown on Wall Street. Increased oil prices do explain that timing, however, because those economies, having to import most of their oil, are more sensitive to higher prices.
According to Rubin, it takes about a year for higher oil prices to hit the economy with their biggest punch. Although prices have been rising now for over three years, it’s been only about a year since the biggest part of the increase began.
Third, the scale of the global problem is too large to be explained by a meltdown in the US housing market. As Rubin says, “Is Cleveland, and all the other depressed property markets in the US, really big enough to deep-six a $60 trillion world economy?”
So, if high oil prices caused the recession, the low prices of the past few months should help to bring some relief. Don’t pin too much hope on a sustained recovery, though, because as soon as the economy starts showed renewed signs of life, guess where oil prices are going? That’s right, back up.
The issue we’re facing here is called peak oil, for short, a reference to the peak of global oil production. What that means is that the 86 million barrels of oil being produced each day is close to the maximum we’re ever going to get. Most experts in the field believe that, at most, we’ll see 100 million barrels per day, which is far short of the 120 million barrels per day that those who forecast sustained economic growth say we’ll need by 2030.
It’s all about the flows, not about how much is left in the ground. Peak oil happens when you’ve gone through about half of the oil, so there’s no doubt that there’s plenty of the stuff left. The US peaked in 1970 at about 10 million barrels per day. We now produce about 5 million barrels per day, and no amount of “Drill, Baby, drill” will ever get us back to 10. We use about 21 million barrels per day.
Facing such a formidable problem, we must make fundamental changes in how we plan for our energy future, and a serious focus on the demand side has to be a large part of our efforts.