Unless you’re Jed Clampett, rising oil prices probably worry you. Higher energy costs threaten to either reignite inflation to levels last seen when leisure suits and disco music ruled the day, or suck every dime out of our pockets before we can spend it on anything else, thereby crushing our nascent economic expansion. With oil prices once again over $100 a barrel, which will it be….inflation or a recession? This time, I don’t think either will be the result, but to get to that conclusion, there’s some history to account for.
During 1973, crude oil prices shot up from just over $2.00 a barrel to the “unimaginable” level of nearly $10.00 a barrel, and inflation, as measured by the Consumer Price Index, surged from 3.4% to 8.7%. One year later, although oil prices had increased only marginally from the prior year’s peak, inflation skyrocketed to 12.3%. Volumes have been written to explain the “Great Inflation of the 1970s,” but to most of us, oil fueled the mess.
You don’t have to remember when “Tie a Yellow Ribbon” topped the song charts (really—you can look it up!) to make the connection between escalating oil prices and a downturn in growth. West Texas Intermediate crude last traded above $100 a barrel in July 2008, and didn’t break below that level until Lehman Brothers collapsed. In fact, a spike in oil prices accompanied each of the last six U.S. recessions. Will we escape this time?
Recall that since the 1974 recession, which could be blamed primarily on oil prices, each recession had a major financial component. In the early 1980s, the Fed attacked inflation with crushing interest rates. In 1990, 2001 and 2007 (remember…the recession was about nine months old when Lehman went down), the real estate and the dot-com bubbles had collapsed. In sum, oil greased the skids, but major asset contractions provided the shove.
Today, it’s hard to find comparable bubbles, and overall economic momentum is positive. Employment, capital investment and consumption are all solid, though hardly exciting. Even at $4.00 a gallon at the pump, energy prices alone won’t be enough to halt this creaking recovery.
What about the dangers of inflation? My one-time teacher defined inflation as “too much money chasing too few goods.” Well, there may be a lot of money around today, but the excess is sitting in bank reserve accounts, not chasing goods. In fact, as of now, we’re scarcely safe from deflation.
We’ll talk more about the Fed later.