- The Washington Times - Sunday, March 13, 2005

Last week the price of benchmark West Texas Intermediate (WTI) crude oil came within pennies of its nominal record of $55.67 per barrel. The recent oil-price run-up has ignited concerns that the trend could take some steam out of America’s robust economy, which has grown by more than 8.5 percent during the past two years. There were also fears that the recent WTI price spike, which reflected an increase of more than 20 percent from one month earlier and more than 50 percent from a year ago, could jeopardize last year’s solid expansion of the global economy.

Neither fear is likely to turn into reality.

But the concern is understandable, given that nine out of the last 10 recessions in the United States have been preceded by a sharp increase in the price of petroleum. Yet there are several reasons why an oil price in the range of $55 to $60 per barrel will be unlikely to derail the U.S. economy in the foreseeable future.

First, while the current oil price is in the neighborhood of its nominal record, previous recession-inducing oil prices, when adjusted for inflation, were considerably higher than today’s price. For example, real (i.e., inflation-adjusted) oil prices approached $90 per barrel (measured in 2005 dollars) during the early 1980s.

Second, during the 1970s and early 1980s, when the world economy was hammered by oil price and supply shocks, the U.S. economy was far more dependent on oil than it is today. During 1981, for example, when the nominal composite oil price (a weighted blend of domestic and imported prices) averaged more than $35 per barrel and U.S. petroleum demand averaged 17.1 million barrels per day, the oil sector accounted for 7.9 percent of U.S. gross domestic product (GDP). This year, assuming an average oil price of $55 per barrel and U.S. daily demand of 21 million barrels, the oil sector would account for 3.4 percent of GDP.

The third reason why the U.S. economy will likely grow by more than 3 percent this year in the face of $55 oil is because fiscal and monetary policies remain very stimulative. The exorbitant budget deficit speaks for itself. And even if an oil-induced spike in inflation causes the Fed to raise interest rates faster than it has since last June, real interest rates are likely to remain very low — particularly for this stage in the business cycle — for the balance of the year and beyond.

While China’s economy shows little sign of cooling from the near double-digit growth rates it has enjoyed in recent years, Japan and the eurozone are another matter altogether. With its economy having declined during each of the three previous quarters, Japan has re-entered yet another recession. Germany, once the engine of the European economy, has suffered two recessions since 2001 and appears to be teetering on the verge of another. The best that can be said is that Japan and the eurozone economies are not exacerbating the world’s increasing demand for oil. And while both Japan and the eurozone complain that their currencies have increased by more than 20 percent and more than 33 percent, respectively, against the dollar since early 2002, the flip-side benefit is that their stronger currencies have significantly mitigated the soaring, dollar-denominated price of oil.

If current supply, demand and price conditions in the world oil market remain unchanged for the balance of the year, both the U.S. and the world economies should continue to advance at an acceptable pace.

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