There’s an interesting dynamic swirling around the impact of Oil and the likelihood (or not) of a possible recession. Some economists are saying that, well, its different this time, and Oil won’t precipitate a recession, that "Expenditures on energy are a sufficiently small share of GDP" that it won’t matter much.
I disagree — not because of the relative size of Oil to GDP, but rather, due to Psychology of consumers in light of inflation, very high Gas prices, weak job creation, Real Wages, and an ongoing messy War.
click for larger graphic:
graphic courtesy of NYT
Over the past decade, we’ve seen several developments that makes the average consumer more sensitive to fuel prices. Most of the country now drives larger vehicles: SUVs, trucks, large sedans. Fuel economy for the average suburban family is down significantly. Combine that with leasing rates that allow people to obtain much more expensive vehicles than they could otherwise afford to buy outright. That put alot of trucks on the road; Drive to any suburban mall or shopping area, and every other car is an SUV.
But it also allowed people to spend and indebt themselves into a position where they don’t have a significant margin of budget safety. Now add to that the two recent wealth effects — stocks in the 1990s, and homes in the 2000s — that led people to feel flush, and further encouraged many of them to live relatively beyond their means.
Which brings us to 2005. While Oil may be a much smaller percentage of GDP today than it was in the 1970s, the relative financial conditions of indebted consumers may also be that much less able to absorb an extended shock than it was then.
There are two stats that always seem to get mustered to counter this: Some point to consumer debt, not as a percentage of GDP, but relative to net asset wealth. The other rationale is median personal income (not just wages) as showing how flush consumers are.
I find neither of these arguments convincing.
As we learned in 2,000, relying on net wealth which is subject to asset price fluctuation can lead to a rapid rise in asset to debt ratios when the values of those assets declines precipitously. When stocks crashed in 2000, suddenly people were sitting on a lot more debt percentage wise than before. Then the negative wealth effect led to a modest curtailment of spending, exasperating a mild recession.
Secondly, median personal income gains paint a misleading picture of the economy. A more accurate measure would be Real Hourly Wages. Thats the data point which impacts the vast majority of consumers, and therefore has the largest impact on spending. After inflation, we see little in the way of income gains. Median income, on the other hand, disproportionately reflects the benefits of tax cuts, dividends, and capital gains. These improvements are real, but not widely disbursed. Thats also why we see a bifurcated spending pattern developing: Wal-Mart’s losses are Tiffany’s gains.
Just because Bill Gates walks into a bar, everyone else in the bar isn’t better off. Sure, the mean income just went up dramatically, but the median is hardly changed. That’s an exaggeration of whats been occuring to personal income in the U.S. — some are doing very well, while others are slipping backwards.
Back to the recession issue: Longtime readers know I am a fan of Chaos theory, periodicy and cycles (or at least the cyclical nature of business ). A possible recession in the 2006-07 time frame is hardly a stretch. Consider the past few contractions, and then fill in the blank: 1990, 1994, 2000, ______.
Its even easier to presume a potential contraction when one looks at how stimulus driven this post-recession period has been, and the net results of what happens as that stimulus attenuates.
Which brings us back to Psychology. How much additional pressure can the consumer absorb before pulling in his/her spending? Despite good economic headlines, consumer confidence is mixed, and the President’s approval ratings have reached the nadir of his term (both Reagan and Clinton scored higher at the same time).
Consider all of the following: Record high gasoline prices, that fall back a little but stay inflated; Add a housing boom that doesn’t crash, but merely fizzles. The ongoing refinacing machine which drove so much consumer spending decellerates rapidly. Add to it a War which the majority of the country now believes turns out to be "Not worth it" and a significant percent (though not quite a majority) beleives we were led into under "false premises." Lastly, the myriad stimulus from the government — tax cuts, ultra low interest rates, deficit spending, increased money supply, military expenditures — all begin to fade.
What might all this a recipe for?
Economy Shows Signs of Strain From Oil Prices
By JAD MOUAWAD and DAVID LEONHARDT
Published: August 17, 2005
Do Higher Oil Prices Lead to Recessions? (Yes)
Sunday, June 06, 2004
U.S. Gasoline and Diesel Fuel Prices, 08/15/05
AAA Fuel Gauge Retail Gasoline Prices
Oil Spike Won’t Cause Oil Shocks of Past
By THE ASSOCIATED PRESS
Published: August 17, 2005