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Destroying The Myth That Lower Gas Prices Boost Consumption
Submitted by Lance Roberts via STA Wealth Management,
The recent plunge in oil prices has brought both optimism and pessimism to the economic landscape. Anyone who lives in Houston, as I do, knows that the price of oil is an important driver of the economic landscape. The plunge in oil prices in the 1980's is a solemn memory for many Houstonians, particularly for those in the oil patch that lived through it.
The problem with falling oil prices, economically speaking, is that oil and gas production make up a hefty chunk of the "mining and manufacturing" component of the employment rolls. Since 2000, when the oil price boom gained traction, Texas has comprised more than 40% of all jobs in the country according to first quarter data from the Dallas Federal Reserve.
Higher oil prices have led to more employment as energy companies explored and developed more aggressively. This has particularly been the case since the financial crisis as cheap financing has lead to an exploration "boom" in "shale fields." However, as I discussed recently, there is a dark side to that "miracle".
"First, the development of the “shale oil” production over the last five years has caused oil inventories to surge at a time when demand for petroleum products is on the decline as shown below."
The drop in demand is being driven, no pun intended, by a change in demographics, a rise in telecommuting, a structural shift in unemployment (large pool of working age individuals outside of the labor force) and increases fuel efficiency. These dynamics are likely not to change in the foreseeable future as economic growth rates globally continue to "muddle along."
The obvious ramification of the surge in supply as demand stagnates is a “supply glut” which leads to further declines in oil prices. As prices fall, energy related business cut production by “shutting in” wells, cutting capital expenditure plans (which makes up almost 1/4th of all capex expenditures in the S&P 500), freezes and/or reductions in employement, and declines in revenue and profitability. Of course, the "ripple effect" of those actions impacts all of the related and ancilliary businesses from piping to coatings, trucking and transportation, restaurants and retail.
Do Lower Gasoline Prices Lead To Higher Consumption
The optimistic argument is that lower oil prices lead to lower gasoline prices that gives consumers more money to spend. The argument seems to be entirely logical since we know that roughly 80% of households in America effectively live paycheck-to-paycheck meaning they will spend, rather than save, any extra disposable income.
This argument is easy to prove by just comparing the annual change in inflation-adjusted (real) disposable incomes (DPI) to real gasoline prices. As gasoline prices fall, DPI should rise and vice-versa. However, as shown in the chart below this has not been much of the case.
Most of the changes in DPI have come from tax law changes, increases in welfare dependency and changes to actual compensation. As an example, the spike in DPI at the end of 2012 was due to massive dividend and bonus payouts in advance of the "fiscal cliff" tax changes rather than the drop oil prices. Importantly, the annual rate of change in DPI has been on the decline since the 1998 peak.
The follow up argument for lower gasoline prices is higher levels of spending by consumers. Again, this is easy enough to analyze by looking at real gasoline prices compared to retail "control purchases." I am using "control purchases" as it removes retail gasoline sales, automobiles, and building materials from the retail sales number to focus more on what consumers are buying on a regular basis.
As with DPI, the argument suggests that falling gasoline prices should lead to a rise in the annual rate of change in retail sales. The vertical orange line shows peaks in gasoline prices which should correspond to a subsequent increase in retail sales.
However, "retail sales" is only about 40% of the Personal Consumption Expenditure (PCE) number that comprises roughly 2/3rds of the economic GDP calculation. Therefore, we can also analyze falling gasoline prices as it relates to total PCE. Again, falling gas prices should lead to increases in PCE.
While the argument that declines in energy and gasoline prices should lead to stronger consumption sounds logical, the data suggests that this is not actually the case. With consumers heavily leveraged already, any increases in disposable incomes from lower gasoline prices are likely negligible in terms of their monthly spending.
Furthermore, as I predicted back in August, the onset of another extremely cold winter will likely detour any savings from lower gasoline prices into higher electricity and heating oil costs.
The most critical impact of a sustained decline in energy prices, at a time when the US dollar is rising, is a deterioration in the economic foundation. Exports of goods and services, which comprise about 40% of S&P 500 profits, are already under pressure from a surging U.S. dollar. Combine that with a sustained decline in oil prices that leads to cutbacks in capex, employment and incomes and you have the potential for substantially weaker economic growth than currently estimated.
The risk to investors is that with financial markets already pushing extremes in terms of bullish sentiment, complacency and valuations, there is little room for disappointment. As John Hussman recently penned:
"Importantly, rich valuations here cannot be 'justified' by appeals to current interest rates or profit margins unless that justification carries with it the assumption that both zero interest rate policy and cyclically-elevated profit margins will be sustained for decades, coupled with the assumption that economic growth will proceed at historically normal rates."
John is right. While interest rates can surely remain suppressed for decades, particularly when economies are caught in a "liquidity trap" like Japan, however, profit margins are extremely "mean reverting." The decline in oil prices is important to watch as energy has a broad reach across the economic spectrum and the financial markets.
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Amnesia
With every generation comes
Another memory lapse
See the demonstrations of
Failing to learn from our past
We live in the dreamtime
Nothing seems to last
Can you really plan a future
When you no longer have a past
>>Sweet Mnemosyne
correlation is not causation, tyler!
Fuel demand is inelastic. How often do we buy a new car?
That's why oil price cycles are usually measured in years, not months.
This country NEEDS a gas price relief to counter Obamacare...
Once things settle out and start picking up again the prices will NATURALLY pick up...
Woo-Hoo, now I can drive even further to find that 3rd part-time job.
My sentiments exactly. Holy shit, I just saved $12 on my full tank of gas. Time to go on a spending spree!!!
The broke, debt slaves will have a little more cash to give to their bankster masters at end of the month. Banksters 1, People 0
"This country NEEDS a gas price relief to counter Obamacare..."
A temporary, and small, relief from one fascist group of oligarchs to offset the pillaging from another via an Unconstitutional mandate/tax/whatever.
Guillotines are a more permanent form of relief.
An American, not US subject.
"Inelastic" fuel demand has been dropping in the USA since 2005. People got rid of their SUVs, bought hybrids and are now beginning to buy electric cars. Gas is replacing oil in home heating. That is the long term trend for gasoline and oil.
Short term, the extremely large margin on oil that went to non-productive middlemen is being eliminated. The big banks handed off to speculators and the speculators are currently being liquidated.
You mean "Lance."
Both.
There is some sort of hair ball denial going on here.
No news can ever be good news. For realz???
Tell this to the dipshits looking to buy SUVs now that gas prices are so low: http://www.cbsnews.com/news/are-americans-switching-back-to-big-cars-and...
I might get a larger vehicle but it sure as hell won't be for some dumbshit reason like gas being 60 cents lower. I'll probably get an SUV so I can drive in the sno rather than sheltering in place when the bad weather comes. Also I like to go places without leaving my family behind. Really difficult to fit your wife, 2 car seats and a dog into a Prius.
Agreed. I just think it's interesting how shortsighted people are, as if the low gas prices will last forever. In the interest of full disclosure, I own a Prius and have 2 kids; the backseat is actually comparable to a lot of sedans. But yeah, a dog would kind of tip the scales toward an SUV. Also, the Duke family lives in the deep South -- we don't have to deal with that snow thing you're talking about. I have no aversion to big vehicles -- they are a cultural birthright here -- however I do have an aversion to shortsightedness on the part of low information consumers.
Progressive backpedaling. No one wants to buy clown golf cart rubbish with a GPS, movie theater console to keep the ADHD children preoccupied for a 20 minute ride. As for the drivers, if you need to be warned about making a lane change with a siren blasting “don’t do it fucking imbecile”.. Your driver’s license should be revoked. Never have placed a DVD in my entertainment center.
Here’s what matters
i would add that dropping oil prices also affects new vehicle sales
less incentive to turn in old gas guzzler (i'm back to driving my 17mpg pathfinder) for fuel efficient new vehicles (especially with insane prices on them)
A LOT of mfg concentrated in the new vehicle supply line
I'll buy a new truck when there is a reason to do so.
ie flex fuel (nat gas or gasoline) and plenty of places to fill up. Until then, not interested.
If you get a flex-fuel vehicle, make sure and learn where the reset switch is on the damn thing. My uncle was bumped in a parking lot last week while driving his, and until you press the reset button, it won't start as there's the danger of fuel leakage.
I believe that switch is present on all modern fuel injected vehicles. Incase there is an accident that ruptures the fuel line, it wont be pumping fuel onto the ground until the battery burns up.
There was an emergency cut off like that on a ford I had driven for five years.
Never heard of such a thing until I drove over a board, on a bridge where I couldn't avoid it, and the fuel cut off.
I thought it must have crimped the fuel line. Amazing the detail crap we don't know any more.
If you fill up once a week and it is costing $15 less per fill up you are saving about $60 per month. In just 2 months you will have enough money to buy 1 share of Apple and it would only take 4 months to buy 1 share of Tesla. Bullish!!!
Three shares of Tesla per year will make me a meellionaire in just 932 years.
<or something like that>
still I will always take lower than higher.
I find it useful to flip and argument upside down every now and then, just to see if it passes the smell test.
If lower gas prices don't boost consumption then higher gas prices shouldn't curtail it either, right? Something tells me that would be very easy to prove wrong.
It boggles the mind to say that the price of a major commodity that touches almost every American's financial life has "no effect". The money goes SOMEWHERE, if it's not spent on expensive gasoline. Even if it just goes into savings or paying down debt, would you say that's a BAD thing? I wouldn't.
There's a directional difference involved here. In this case, the fact that many people no longer have any disposable income, regardless of changes in fuel price.
If gas goes down, the "extra" money just gets spent on yet another debt they need to pay down, like the late fee on last month's mortgage.
Most gasoline is bought on a credit card. Lower prices for a few weeks or months does not have a large effect on the minimum amount due. It just means the balance is not increasing as fast as before. It doesn't give anyone any extra cash in their pocket to go out and spend. The real life situation for most people is far more complicated than any chart or graph can depict. Economics does not reflect real life.
There is consumption and then there is excess consumption. The economy has been running on consumption during this recession where only necessary items along with a few "luxuries" are purchased usually during tax return time or any kind of bonus time. Gas prices don't affect excess consumption which is what people really mean when talking about a "healthy" economy. That is when people can buy luxuries on a weekly basis.
"Economics does not reflect real life"
Oh, you've just never met a good economist before. Good economists would take into account the delay in lower price realization (which you are absolutely correct about).
But no matter how you slice it, if gasoline prices are dropping, there is extra money available for SOMTHING else. Furhter down the road, energy costs trickle into other goods and services (almost everything has an energy component to it's cost), lowering their prices as well. Or at least flatting their rate of increase.
Agreed, looking only at the immediate-month (short term) effects is no more useful than looking at a single glass full of sea water and concludign there are no fish in the ocean.
So many details, so many variables. It hurts the heads of all of these baby boomers in the voting majority.
Things were so simple then when real estate values only went up and up and up(propped by subprimes propped by illiquid banks who were only liquid with the petrodollar)-
Speaking of which. I wonder what bought off the writer's bias.
@ no debt
Your analysis of benefits due to lower gasoline prices neglects a few other effects (of import). In my original home state (Texas) many people have (however small) mineral rights to oil and gas property. I have also an operating interest in regular gas wells. My income has dropped precipitously and we can't afford to drill deeper wells yet, because the price of nat gas is too low to justify the risk. Many small farmers throughout Texas are quite dependent on their mineral rights income. The artificially low interest loans available to the FRACKERS results in malinvestment. Many of these companies started shale gas fracking when prices were much higher and the depletion rates were not so obvious. Now these companies are flipping their proven (supposedly) fields to less aware investors (often from China). The income gain you see is somewhat balanced by income loss elsewhere.
Transportation costs are imbedded in everything we buy so lower fuel costs make us all weathier. Whether that translates directly to increased consumption, or the ability to pay debts down faster, or greater savings, or whatever...lower fuel costs make us weathier by making our money go further. This author seems to be making the point that lower fuel costs don't help the economy somehow because his charts and graphs focus on consumption only and not all the other things we might do with the extra money.
Here's the thing - oil prices are more manipulated than just about anything.
Oil has been overpriced for years. We are seeing, obviously a deliberate effort to lower the price to hurt Russia [and probably to hurt shale enterprises at the same time] but this artificial lowering is actually bringing the price closer to what it would be if there wasn't so much fuckery in terms of production caps and speculation.
Jesus, by the logic here, if Joe pays less for gas than he normally does, he doesn't save any money.
He sure does.
But he just may put the extra $20 on his mortgage or credit card.
20% more disposable income buys 20% less food than a year ago.
This is the crappiest post in ZH's history
Destroying the myth that ZH only posts good articles.
I said it before and I'll say it again. SAVING MONEY AT THE PUMP DOESN'T MEAN I'M OVERFLOWING WITH EXTRA CASH!!!
Come on people. We're smarter than this. If I fill up once a week $4/gal and it comes down gradualy to $3/gal, then I'm only saving what? An extra $12/wk? Is that the BOOST IN CONSUMPTION that people are believing in?
Am I supposed to make it rain on dem hoes with an extra $12??????
when all those un counted un employed, get jobs watch the price of fuel..or for the more dense..a robust economy will consume more of everything esp energy..duh -deflation a weak economy will result in low energy prices, no jobs= no income (that allows descretionary spending), .gov handouts cannot stimulate descretionary spending..so super rich get more wealth but fewer or no new super rich are created, we get economic stasis..this can go on for a very long time and has gone on the last 6 years. what can change this? no one in leadership can they are happy to have a crisis that never ends so they keep power. If you have wealth and power things are just fine.
Well it's complicated.
First, the GDP consisted of gas purchases in the recent past so high gas prices = forced consumption (price inelasticity).
Come to California where the status quo is either driving a lifted truck or a gas guzzling SUV with a "save Tahoe" sicker on the bumper tossing away $80-$160/fill up. This is only before insurance, repairs, etc.... before the lease another one. Driving a Toyota Sedan saves modestly, I would say that fill up on 10 gallons might be $40 (Approximately). AD distance traveled not just to and from work, but to the drive through at Starbucks for only one boomer passenger, traffic jams, spontaneous trips to like, Vegas...
On either their equity line, their subsidies and only a few on real earnings.
If that $160/ fill up goes down to $100/week (well that's the amount some people pay in rent)---- for people like me who are forced to be real in this economy- that money might go to ... debt. Medical bills. Parking tickets. Food. Medicine. ANYTHING BUT UBER!!
Again capital expenditures elsewhere that won't look better on the GDP readings for obvious reasons.
Gasoline purchases ARE consumption.
They provide something of value to the buyer that any commodity does.
Swapping one purchase for another does not boost the economy.
The article mentions a boost in RETAIL comsumption attributed to falling gasoline prices. I hope these mother fuckers are betting the farm on it. Prices could come down another dollar per gallon and I'm still not going to be making it rain. Most people won't be.
I hope these same assholes believing in this are hoping for a massive holiday shopping season with all of those gasoline savings and pent up consumer demand. Give me a fucking break.
As it is my family has had go full on Yankee Swap instead of buying a gift for everyone.
min credit card payment is not impacted,
The gas price is like the oil price : it includes costs for reserves and future expenses .
See http://andreswhy.blogspot.com/2013/04/petroleum-price-and-clathrates.html .
Expectation of the demise of the entire industry strips out these extra margins and the cost falls dramatically for no apparent reason .
http://andreswhy.blogspot.com/2014/11/laundry-economics.html
The customers have also sniffed this in the breeze and is waiting for prices to drop further .
Hence the lack of increased demand .
A Classic Deflation .
it's too bad paying down your debt doesn't count for shit in most economists' thinking, eh?
BTFD
I need a larger gas tank on my car so I can load up on the FD! I gotta start driving more so I can take advantage of those low prices!
The preposterous thought of increasing automobile mileage so they can still go out shopping has backfired.
Any fuel savings I realize are already more than eaten up by my mandatory flood insurance premium increase and my 2015 health care premium increase.
This would appear to be an attempt to contradict 'Supply And Demand' using the local Houston oil economy as anecdotal evidence.
But that is not the only problem with the article's logical framework. There's also a bait-and-switch. There's this:
"Do Lower Gasoline Prices Lead To Higher Consumption
The optimistic argument is that lower oil prices lead to lower gasoline prices that gives consumers more money to spend."
This statement ASSUMES that oil and gas aren't subsidized, and that CPI deflators are accurate. Neither assumption is true. If Oil and Gas are subsidized, then lower gas prices CAN'T lead to increased consumption...because prices are lower BECAUSE OTHER CONSUMPTION WAS REDIRECTED TO LOWERING GAS PRICES.
That is what a subsidy is: a redirection of means away from consumer choice toward the government's choice. What might consumer's have done with those dollars before government taxed them away and used them to subsidize gas prices?
AND THEN THERE'S THIS STATEMENT:
"Most of the changes in DPI have come from tax law changes, increases in welfare dependency and changes to actual compensation."
This is a physical impossibility.
Tax law changes only change who gets to spend the money, government or taxpayer, and does not change how much money there is to spend. If the government chooses to put more or less money into the hands of the FSA - welfare recipients, and if the total number of welfare recipients (currently being imported) increases or decreases, IT HAS ZERO EFFECT ON INCOME. Again, the government runs a deficit, and will therefore spend this money.
Whether the money is spent by a Washington Bureaucrat or Pregnant Single Hispanic Immigrant mother is irrelevant to the number of dollars spent.
The author has either not thought this through - or he has and is pulling the wool to promote an agenda. Either way this line of reasoning is faulty.
When the average person spent 70 dollars a week for fuel, and is now spending only 50 dollars, 20 dollars are going to another part of their budgets.
But, the minute citizens get a break from OPAC, the states want to rise the tax on gasoline to pay for road improvements, already taxed 40-50/% a gal.
I think the majority of gasoline is purchased with credit cards. So, lower gas prices slows the accumulation of debt, which slows the expansion of the money supply.
I wonder if that was their intent?
High gas prices altered my driving habits forever. I don't drive now until I can take care of multiple things in one trip. My gas consumption is down so much it's like seeing the savings from quitting smoking. Changing choices save me a ton of money.
No, lower prices don't boost consumption, because you need lower prices across the board. And gas prices are still far from as low as they were in 2000 and before. None of us will live to see gas prices that low again.
they don't count food, or energy costs into cpi any longer.
a good %age of americans are balancing their budget between food and gas.
maybe the $10 a week the average driver saves in gas, he may buy his family a small roast.
maybe all the factories will fire back up to take advantage of low oil prices, oh thats right they shut-down because they weren't sell anything, and trucks are sitting idle.
this is a saudi, american govt. conspisacy to f--k the frackers, and russia.
most people i know are like the people who get on game shows, win a car, and have to sell it back to the game show because they can't afford the taxes, and license on it.