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The ‘High Oil Prices = Recession’ Fallacy
Every time we see oil prices go up we hear that it will cause inflation and/or the economy will go into the tank.
... 7 out of the 8 postwar U.S. recessions had been preceded by a sharp increase in the price of crude petroleum. Iraq’s invasion of Kuwait in August 1990 led to a doubling in the price of oil in the fall of 1990 and was followed by the ninth postwar recession in 1990-91. The price of oil more than doubled again in 1999-2000, with the tenth postwar recession coming in 2001. Yet another doubling in the price of oil in 2007-2008 accompanied the beginning of recession number 11, the most recent and frightening of the postwar economic downturns. So the count today stands at 10 out of 11, the sole exception being the mild recession of 1960-61 for which there was no preceding rise in oil prices. [Hamilton, 2009. Rv. 2010]
The premise is wrong. What causes price inflation is an expansion of money supply (and a desire of people to spend it, often quickly). What causes recessions is malinvestment of capital caused, again, by money supply expansion.
The classic argument is that because 70% of the economy is driven by consumer spending, an increase in gasoline prices will cause a decrease in consumer spending, which will cause an economic decline. Sounds logical on its face. There are empirical studies that show either increases in gasoline prices will not impact discretionary spending (McCarthy, 20110) or that large increases in petroleum prices will cause recessions (Hamilton). Take your pick.
The above chart1 shows the peak of real YoY GDP percentage change (light blue lines) and the relative price of gasoline (red), the product that most directly affects consumers. If gasoline prices have been increasing prior to the peak, then there is statistical data showing that those prices may have had an impact on GDP. From that one might conclude that because oil prices were rising prior to the peak in GDP, and because GDP subsequently declined, then high oil prices may have caused a decline in GDP. (Because A happened and then B happened, thus A caused B?) Or, is it just a coincidence?
What we see in the data is coincidence rather than confirmation.
Take price increases of oil and gasoline. It doesn't cause price inflation (i.e., all prices rise). Instead it's a supply and demand thing. When OPEC jacks up oil prices, people spend more on gas and less on other things. The consumer goods they don't buy decline in price. Money is redirected by market forces to petroleum producers who are incentivized to discover and produce more oil. Ultimately, under normal circumstances, prices come down. This process is a bit distorted because we have a cartel-controlled market. But, if OPEC keeps prices too high, people reduce consumption, cartel revenues go down, and OPEC reduces prices to stimulate consumption. This is what happened in the current business cycle.
It is the same with recessions and oil prices. Each of the recessions we've had in the last 40 years can be adequately explained by causes other than oil/gas prices. For example, while oil/gas prices shot up prior to the 2008 Crash, no one suggests that was a cause of it. Rather we know that oil prices went up as a result of a fiat money fueled boom that drove up all commodity prices.
Looking at our chart, we can start with the 1973 - 1975 recession. That was the time of the Arab Oil Embargo (Oct. 1973 to March 1974). If the theory that high oil prices equals recession holds true then why did the economy recover when gas prices continued to rise post-recovery? What really happened was that the Fed cut interest rates by half in 1970-1971, and then started raising them in 1973 to combat rising prices. By the time the recession started in November 1973, the Fed Funds rate peaked at just over 10%. It isn't as if the oil embargo didn't cause disruption in the economy; it did, but most of the economic disruption was caused by the government's price controls and rationing. But it didn't cause the recession.
Next, GDP peaked in April 1978 (gasoline-PPG $0.631) and declined until October 1980 ($1.223). Recall that price inflation almost hit 15% in 1980. The recession started in January 1980 ($1.11) and ended in July 1980 ($1.247). Gasoline prices continued to increase during the subsequent recovery. There is no correlation between oil prices and recession or price inflation.
GDP peaked again in Q2 1981 ($1.353) and bottomed out in November 1982 ($1.268). We went into recession in July 1981 ($1.353) until November 1982 ($1.268). You can see an oil price correlation here, but other things were going on: high inflation. By June 1981, the CPI was still over 10%. Carter had appointed Paul Volcker as Fed Chairman in August 1979 and he started raising the Fed Funds rate from around 10% until it reached 19% in January 1981, and kept it high (8% to 10%) for much his term (ended in 1987). This broke price inflation (it settled in the 3.5 to 4.5 range). Thus monetary policy rather than oil prices was the cause of the recession.
From then on, gasoline prices declined and remained relatively stable until 1999 ($0.90 to $1.30) when it started climbing again. The July 1990 ($1.139) to March 1991 ($1.138) recession shows that GDP peaked in late 1987 (about $0.95) and gasoline prices peaked in January 1991 ($1.304) and the recession ended in March 1991. But again, other things were driving the economy: a real estate boom-bust cycle, and that was largely driven by cheaper money and accelerated depreciation rules (those rules ended in 1986).
Prices fluctuated but remained in the $1.20s for most of the next eight years.
By 1999, the rise in gasoline prices coincided with peak GDP in late 1999 (Dec., $1.353) and gas prices rose, almost steadily since then. The 2001 recession came and went (March-$1,503) — November-$1.324). But, what else was going on? This was a time of incredible production and technological innovation that again benefited from the Fed's cheap money (spurred by Greenspan to revive the economy from the 1990 - 1991 recession). It worked. But Dot Com boom turned into Dot Bomb bust as the Fed raised interest rates and cooled the economy off from its "irrational exuberance".
The Fed decided it needed to stimulate the economy from the bust and from November 2000 to June 2004, the Fed lowered interest rates from 6.5% to 1.00%. From then on oil prices followed commodities prices and gasoline prices continued to climb.
By late 2003 ($1.578) the rate of growth of GDP peaked and thereafter was slowing, although it continued to grow until January 2006 ($2.359). At this point, the Fed again sought to cool down the economy and the Fed Funds rate went from 1.00% up to 5.26% by July 2007. Again, it worked and the real estate markets began to come apart. By H2 2008 ($4.142), GDP began to decline, thus beginning the bust phase of our current boom-bust cycle. Current price is $3.591.
Thus, while you can argue that rising oil and gas prices may have had some negative effects on the economy because of some economic disruption, in every case, the cause of our recession was anything but rising prices.
Regardless you are still going to hear that rising oil and gas prices are going to ruin the economy and cause us to go back into recession. While I believe the economy will decline starting in H2 2012, the reasons have nothing to do with oil prices. Don't let the pundits scare you with this economic fallacy. There is enough to worry about.
1. Note that gasoline prices (red line) are not scaled to prices, but are scaled to an index (100). The GDP scale (blue line) shows YoY percent change.
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Let's go get those other worldly methanes. The EROEI should be something like 1 unit returned for every million units invested.
Quit with the fucking strawman....
Methane is not oil... capeche?
Why didn't you discuss the biological markers in the Bach Ho field? Or the sedimentary layer beneath the highly fractured granite?
And as for abiotic oil, care to discuss the observed C13/C12 ratios and how that compares to non-biological sources?
And don't act like a candy assed baboon if some one calls you out....
FWIW, I have worked with many Russians in physics academia in fact I use to share an office with one when I worked at BNL....
Edit: You also might want to brush up on Extended Reach Drilling and what "depth" actually means...
Ever been to russia, cocksucker? You're just bending over backwards to suck your own cock.
I was married to a Russian mathematician who worked with mechanics to model up how all this stuff works. There aren't many math heads like that here.
You don't like a couple of links talking about an abiotic theory that the russian are finding success with....your problem.
Keep sucking your own dick. You don't want folks to know there is an abiotic theory. Have fun with that.
My, my... you didn't learn to play in the sandbox very well with others...
How can a grown man write an article in these times without assessing the effects of dishonesty in the market?
It bothers me that our distinguished economic types consistently just GLOSS right over these kinds of problems.
As if they dont' exist.
And then, they can admit it has been shown there is some funky business going on, where gas price spikes are associate with 10 out of 11 recessions, not including one in the early 60's mind you.
So what folks are seeing isn't really what they are seeing?
I posted this as a primer for my friends on facebook. The original essay v. the mounting criticisms of it are going to be text book.
Gail says to expect both inflation and deflation too. It's on tv so it must be true!
http://www.google.com/url?sa=t&source=web&cd=1&ved=0CCUQtwIwAA&url=http%...
True rocket scientist here. SRAM
Your credentials?
Businessman. Someone who actually puts his own money to productive use (and not in designing things that kill people)
Done my fair share of commercial work. Solved the infamous mixed track bug in early TCAS making the sky safer for pilots and passengers. Project hero on a dozen commercial airplane projects. Regarding work to support our troops and leaders, speak softly but carry the biggest stick you can find got us out on top of many world and international situations. Work supported my family too.
If you are predicting deflation then you must really be valuing that fiat money. Hang on tight while the fed keeps increasing its supply. We will see if it buys you more in the future or not. Same or less goods and services with YoY 10% growth of money and no end in site plus a government that can easily take up the slack in consumer spending with war, bridges to no where, bad loans and medical services.
"If they drive less, they continue to spend on other consumer goods, so all's well .
"So all's well"??? Really?
How much thought did you give to that nonsense before you wrote it? You write that as if it's a proven fact that spending on other goods will continue unaffected. Why does it necessarily follow that they will continue to buy as much of the other consumer goods?
Did you consider that they might cut back on those other consumer goods because the price of them has also increased due to the increase in fuel? In which case the suppliers of those other goods will either sell less because the price is too high or, to keep the price the same, they suffer margin compression. Either way, their profits will be hit.
If fuel increases weren't a contributing cause of recessions, according to your logic, gas could rise to $100 a gallon or more and it could not cause a recession because "all's well" no matter how consumers' income is spent as a result.
Econophile has just outed himself as a Govt Disinformation Specialist.
Econophile is a hard money, anti-Fed, anti-government, Austrian theory analyst and libertarian. You can believe what you want to believe and not let facts complicate things for you.
I think he's trying to weed people out....
On the other hand, it's nice to know my neighbors with the monster trucks will be paying more for the burnouts they do down the street at 2am.
True, but known.
Petroleum products are used in transportation, agriculture, plastics, etc.
When the price of oil goes up, more money is diverted to the oil producers/distributors --leaving less available purchasing power for everything else, thus reducing purchases and production.
In short, the oil distributors get fat, whilst everyone else goes hungry because they have given a bigger chunk of their income/wealth to oil companies.
The fallacy of the article mostly originates from ignoring the inelastic demand for 'oil'-igopoly supplied oil. Eventually, given high enough oil prices, alternatives might be found, but it wouldn't happen right away.
So, let me get this straight. The guy who operates a carpet installation business, and uses a large van that gets 11 miles to the gallon, is just fine shelling out 400 bucks more a month. I could go on and on. Finally, anyone one who believes govt numbers are fucking imbeciles. The very nature of these metrics is to decieve.
But, it's election year and they have to start trumpeting that high oil prices are not a problem so they can get their guy in
So Econophile is Obama's errand boy too?
I am sure that Bernanke will send everyone a check with this note "Sorry, my QEn program forgot to include this gas premium".
How convenient that high gas prices don't cause recessions in this here election year. Expect to see this trumpeted loudly and widely over the next several months!
So reading between the tea leaves, we can conclude that high gas prices will continue.
do you mean to say we actually elect people who lie to us?
What a Full O' Crap article that was. Does EcoNomiSteR work for Big Oil?
Other than Tony Bonn (thanks, Tony), most of you are not reading the article.
True, GDP is not a very good measure of economic activity since all it does is measure spending. If spending were the cure to what ails us, all the Fed would have to do is massively print money and we'd spend like crazy. It doesn't work that way.
But, that aside, since most folks follow GDP as an economic tell-tale (including most economists), then what happens when oil prices go up? As I mentioned, either people pay the price or drive less. If they drive less, they continue to spend on other consumer goods, so all's well (they sure as hell aren't saving much). If they spend more on gas and less on consumer goods, then money flows to petroleum producers. They spend more on equipment, drilling, hire more workers, and they spend. This is what is happening now in the US and Canada. While not entirely a linear effect, it's as if the money spent is redirected to other consumers (oil workers) who spend on consumer goods. This is called in economics the difference between the "seen" (people spend less because of high oil prices) and the unseen (new consumers created because of new oil exploration and production). Again, as I said in the piece, it isn't as if higher oil prices has no negative effects on the economy, but it isn't the cause of recessions.
Thanks for the comments.
"If they spend more on gas and less on consumer goods, then money flows to petroleum producers. They spend more on equipment, drilling, hire more workers, and they spend. This is what is happening now in the US and Canada."
That'd be true if we only got our oil from domestic sources and Canada.
So we have another idiotic comment from you Econophile. I think the other guys have pegged you right. You must be on the Obama economic team.
+1 for having the guts to come out and defend your thesis (right or wrong) in a hostile crowd.
Other than agreeing with me, that's one of the nicest things anyone on ZH has ever said about any of my posts. My gripe here is that most readers seem to be stuck on the Conventional Wisdom and refuse to actually read what I write. This has become a forum for irrational flaming. But venting doesn't make me wrong. There are so many economic fallacies floating around and this is one of them. If they wish to make investment decisions on bad ideas of how the economy works, that's going to cost them. My track record isn't perfect but it's pretty damn good. So, thank you very much for your kind comment.
PS The negative comments don't bother me, but ignorance does. And ... I bite back.
But you deny peak oil is at the real root of the problem...
Any article on oil must take into account the changing landscape of supply and demand....
Printing only exacerbates it....
This time it is different...
excellent piece. spot on. too bad most here can't recgonize the truth in your statement. A tell tale sign the central bank will escape responsibility for the coming problems because people will blame every other cause they can think of beside the culprit , an increase in money supply.
Re. higher oil prices ... isn't /aren't/ the cause of recessions.
Econophile. Fail. Right here. In your summary, above. Simple.
You're looking at this via a single lens when in fact there are multiple factors... I think people are cutting back and thinking seriously about paying down debt (we're seeing this in the cratering of gas consumption). They've tapped their savings and are now ready to hunker down and save. The rising price of gas only intesifies the effort to save. It's not "oil goes up, economy goes down," but rather, "Now I can pay down less debt, so we need to cut back even more." Higher oil/gas is simply a catalyst for deeper cuts in discretionary spending... Regardless of which came first, the economy is beginning a steep slide downward as demand dries up across the board... Yikes!
Rising unemployment in so many places would seem to contradict your logic. Youth unemployment is high in a lot of countries and the trends seem to be getting worse which contradicts your logic and conclusions too. Real unemployment trends such as shown at shadow stats also contradicts your assumptions.
So, what you are saying is that the seen ("people spend less because of high oil prices") will be offset by the unseen ("new consumers created because of new oil exploration and production")?
I wouldn't want to bet my tax revenues on that one if I was a gov't entity that relied on taxes, or any business waiting for consumers to spend. What it does is create little geographic pockets of economic prosperity in a handful of industries for the boom areas(like a new production facility), while the rest of the country and all other industries slowly fades into lower economic spending roles.
'Again, as I said in the piece, it isn't as if higher oil prices has no negative effects on the economy, but it isn't the cause of recessions."
It does not have to be the definitive cause, but it sure is one heck of a trigger and a huge catalyst in tough economic times.
Go to North Dakota and see what's happening there.
I stand by my original comment that IMHO you're a flaming idiot enveloped in pure oxygen. When oil spikes up this much this quickly during wage stagnation it means that discretionary spending for non-essential goods declines which also means loss of more jobs. Loss of jobs equates to exacerbating the effects of recession and depending on the degree of job losses also equates to the effects of a depression.
Summarization: Fuel being an essential good over-competing against non-essential goods in debt-derived economies reliant upon discretionary spending to maintain a significant portion of GDP is most certainly a precursor to and an accelerant to recessions.
spot on! ... or put broader, debt-derived economies are evolved animals of a cheap ever expanding energy resource, soon to be extinct.
I understand the reason and logic in your article. Put it this way $4.50 gas will put all the remaining small construction companies out of business. You know the ones that refuse to let go.
This article is a example of how you can use indices and scale of those indices to manipulate the raw data.
Go to the FRED site
http://research.stlouisfed.org/fred2/graph/
and make your own chart using the the following "raw data"
start with prices, commodities, WTI spot from 1970 to current, note the spike in the price of WTI is in very close proximity of EVERY gray recession bar....
Roughly 7 recession bars from 1970
1970 discount the first (data not on chart),
1975 oil price spike, gray bar recession
1980 oil price spike, gray bar recession, double dip recession again in 81-82
1990 oil price spike, gray bar recession
2001 recession, oil price run up and spike just before recession starts
2008 well we all know about that...
WTI price and recession "noise"......rotflmao
What I would like to do is plot the recessions with the oil price and the amount of net oil we are importing into the US on a monthly basis..... got to import data from eia and FRED site to custom chart... not today, my todo list is to long!
Post hoc, ergo propter hoc.
basia culos meos
the single minded model of economics which recognizes an act may have a reaction, but ignores the plurality of cascading reactions from the initial and subsequent acts.
A cause b, therefore it could never cause c or d etc.
that is not at all what he does. he says that it can have negative facts he is merely pointing out it is not the root cause and often not even correlated.
We are talking More Expensive Energy not sure what the problems is but economist seem to have faith in perpetual motion. A bunch of foolish astrologers you are!
"Regardless you are still going to hear that rising oil and gas prices are going to ruin the economy and cause us to go back into recession. "
Seems to me like back in 2008, Oil prices were considered to be one of the reasons for the crash. Maybe it was just a a sign, either way, this article attempts to go deep and fails at all levels. Instead of writing off the wasted time having spent reading this article, I'll waste a few more to say a few likely (un)read words...
First, I don't think we ever left the last recession (and it could be debated that we never left the one before that either), so there is no 'go back into recesssion'. Main Street is there, right smack dab in the middle of it. Nearly half of all people here in the US get some form of subsidies, services or payments from the government. That doesn't sound like a healthy economy to me... but what do I know about math, I'm not a politician or banker, I just balance my own checkbook and when I have no more money, I have no more money. Credit only buys time to spend and pretend. My earning power and most others won't grow enough to cover that credit borrowed, EVER again...
While some people can afford to 'get by' at $4 or $5 dollars a gallon, even they are affected if not so much by the actual outflow of dollars but in the mindset that its now 4 and rapidly moving to 5 bucks a gallon. Perception wins everytime and the perception is things are going bad to worse and people are hunkering down again further spending wise. Whoever denies the fact that it affects Main Street mentally and causes people to pull back spending, needs a handy helping of reality
"don't think we ever left the last recession (and it could be debated that we never left the one before that either)"
comment of the string award
The author of this article IMHO is a flaming idiot enveloped in pure oxygen.
Don't any of you Bitchez suggest that a massive conversion to NG at $2.50 per MMBtu is the answer to ending the towel head’s strangle hold on our collective scrotums. Additionally, do not utter a single syllable as to the concomitant drop in unemployment associated with such a ridiculous protocol!
Just Don’t! (sarc)
Ok.... pop quiz for you
1) Is the US currently a net importer or exporter of Natural Gas?
2) Current US production of NG is equivalent to how many barrels of oil per day (on a BTU basis)
3) If indeed the US has a 100 year supply of NG, how long does it last if you increase production at a rate of 3% a year?
Finally, what fraction of US oil imports come from "towel heads"?
Where does Econophile dig up this dreck???
the industry?