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Rising Oil Prices Pose New Threat to Economic Recovery

Rising Oil Prices Pose New Threat to Economic Recovery

The US economy just can’t catch a break! Last year, as things started looking up, the European debt crisis flustered the fragile recovery. Now, under similar economic circumstances, comes the turmoil in the Middle East: first Egypt, and now Libya, Bahrain and possibly eventually Iran – the latter three being oil-producing nations. As a result, energy prices have surged in recent days, and the political violence in Libya that has disrupted oil production there. Prices are also climbing because of fears the unrest may continue to spread to other oil-producing countries.

If the recent rise in oil prices sticks, it will most likely slow a growth rate that is already too sluggish to produce many jobs in this country. Some economists are predicting that oil prices, just above $97 a barrel on Thursday, could be sustained well above $100 a barrel, a benchmark. Even if energy costs don’t rise higher, lingering uncertainty over the stability of the Middle East could drag down growth, not just in the US, but around the world. “We’ve gone beyond responding to the sort of brutal Technicolor of the crisis in Libya,” said Daniel H. Yergin, the oil historian and chairman of IHS Cambridge Energy Research Associates. “There’s also a strong element of fear of what’s next, and what’s next after next.”

Before the outbreak of violence in Libya, the Federal Reserve had raised its forecast for United States growth in 2011, and a stronger stock market had helped consumers be more confident about the future and more willing to spend. But other sources of economic uncertainty besides oil prices have come into sharper focus in recent days. After a few false starts, housing prices have slid further. New-home sales dropped sharply in January, as did sales of big-ticket items like appliances, the government reported Thursday.

Though the initial panic from last year has faded, Europe’s deep debt problems remain, creating another wild card for the global economy. Protests turned violent in Greece this week in response to new austerity measures. Budget and debt problems at all levels of American government – Federal, state, county, cities, towns and special taxing districts – also threaten to crimp the domestic recovery. Struggling state and local governments may dismiss more workers this year as many face their deepest shortfalls since the economic downturn began, and a Congressional stalemate over the country’s budget could even lead to a federal government shutdown. “The irony is that we just barely got ourselves up and off the ground from the devastating financial crisis,” said Bernard Baumohl, chief global economist at the Economic Outlook Group, who had been optimistic about the country’s prospects. “The recovery itself is less than two years in, and we haven’t yet seen jobs make a decent comeback. Now we’re being hit with this new, very ominous event, so the timing couldn’t be worse.”  In the last week, oil prices have risen more than 10% and even breached $100 a barrel. A sustained $10 increase in oil prices would shave about two-tenths of a percentage point off economic growth, according to Dean Maki, chief United States economist at Barclays Capital. The Federal Reserve had forecast last week that the United States economy would grow by 3.4 to 3.9% in 2011, up from 2.9% last year.

Higher oil prices restrain growth because they translate to higher fuel prices for consumers and businesses. Mr. Lafakas estimates that oil prices are on track to average $90 a barrel in 2011, from $80 in 2010, an increase that would offset nearly a quarter of the $120 billion payroll tax cut that Congress had intended to stimulate the economy this year. Rising gasoline prices have already led Jayme Webb, an office manager at a recycling center in Sioux City, Iowa, and her husband, Ken, who works at Wal-Mart, to cut back on spending. In the last month, they have canceled their satellite television subscription and their Internet service. They have also stopped driving from their home in rural Moville to Sioux City on weekends to see Ms. Webb’s parents. These little changes, multiplied by millions of American households, if sustained, could spell trouble for the US economy.

Along with making their commutes to work more expensive, rising oil prices have driven up the cost of food for animals and people. So the couple have stopped buying feed for their dozen sheep and goats and six chickens and instead asked neighboring farmers to let them use scraps from their corn fields. A cutback in consumer spending reverberates through the economy by crimping businesses, making it less likely that employers will commit to the additional hiring needed to lower the 9% unemployment rate. “It’s a struggle,” said Ms. Webb, 49. “We have to watch every little penny.” The same is true for small businesses across the nation. “Revenue is down, costs are up, and you can’t make any money,” said R. Jerol Kivett, the owner of Kivett’s Inc., a company that manufactures pews and other church furniture in Clinton, N.C. “You’re just trying to meet payroll and keep people working, hoping the economy will turn. But it just seems like setback after setback after setback.”

And the money that consumers and businesses spend on oil often does not stay within the American economy. Nor do the expanded coffers in oil-producing countries raise demand for American exports, because they often bank it as reserves. “The countries that are getting this bonus basically get an enormous benefit,” said Raghuram G. Rajan, an economics professor at the University of Chicago. “But if they can’t spend it quickly, it doesn’t add to aggregate demand.” The rise in oil prices could also create a vicious cycle, as higher energy costs propel already rising food prices, which in turn can lead to more political unrest and more global uncertainty.

Even without the Middle East, the domestic economy has a number of weaknesses that have proved hard to overcome. The recession was provoked by housing and worsened by housing, and housing is likely to remain frail in parts of the country until the end of the decade. After a couple of brief growth spurts, home prices have started declining again in earnest. This week, the Yale economist Robert Shiller speculated about another drop as large as 25 percent. Anything close to that would push millions more households to the point where they owe more on their houses than the houses are worth, generating a lot of sour moods — which can depress consumer spending — more foreclosures and potential job losses… Read more here.

Source: New York Times Cartoon:



Elison Elliott

Elison Elliott , a native of Belize, is a professional investment advisor for the Global Wealth and Invesment Management division of a major worldwide financial services firm. His experience in the global financial markets span over 18 years in both the public and private sectors. Elison is a graduate, cum laude, of the City College of New York (CUNY), and completed his Masters-level course requirements in the International Finance & Banking (IFB) program at Columbia University (SIPA). Elison lives in the northern suburbs of New York City. He is an avid student of sovereign risk, global economics and market trends, and enjoys writing, aviation, outdoor adventure, International travel, cultural exploration and world affairs.

Areas of Focus:
Market Trends; International Finance; Global Trade; Economics