The Trump tax cuts were supposed stimulate growth, and while conventional wisdom held that it would be the US economy that would be boosted, it now appears that only US oil companies, or rather their shareholders (and the occasional OPEC member) will get the benefit of the extra cash jolt.
The reason: sharply higher oil prices, which today settled at a fresh 4 year high, are dragging gasoline prices across the country higher, and are rapidly approaching the psychological $3/gallon level, last seen in late 2014, just before the "OPEC Thanksgiving massacre" of 2014.
To some, the rising prices are merely a nuisance of life. Take Tim Rogus, a retired publisher in suburban Chicago, who told the FT he noticed fuel prices at the petrol station creeping up towards $3 a gallon but he is philosophical about it. “Our prices were nearly $4 at one point,” he says. “Life has to go on somehow.”
To others, especially those in the lower income quintiles, the rising gas prices will be a far bigger burden as it will mean a sharp drop in discretionary spending. now that more cash has to be set aside for essentials. Here, the FT is correct that it will be most rural areas and middle-income households that are about to be hit the hardest.
Worse, it means that the benefit of Trump's tax cuts for the middle class will be mostly, if not fully wiped out.
To be sure, it will take a while for the effects of higher oil/gas prices to be fully felt: the “driving season”, the peak of petrol consumption in the US, is April to September, and the EIA expects prices this summer to be at their highest for four years, up 10 per cent from 2017. Of course, for that to happen, US households will need to significantly curb their spending on other items, which means the weakness in retail sales for a US population whose personal savings rate is already near all time lows, will persist.
However, unlike the last time gas prices soared - most notably in early 2008, just before all hell broke loose - this time there is a silver lining: the US shale industry, which produces more oil the higher prices rise.
"Ten years ago, White House economists looking at gross domestic product and job creation would be quite concerned if oil prices rose significantly,” saidJason Bordoff who leads the Center on Global Energy Policy at Columbia University. “It’s a different world now."
When oil prices fell sharply after the summer of 2014, the net stimulus to the US economy was “effectively zero”, wrote economists Christiane Baumeister and Lutz Kilian in a Brookings paper in 2016. The boost to consumers from cheaper fuel was cancelled out by a slump in investment in the oil industry. As oil prices rebound, the overall impact on US growth is similarly likely to be very small, Mr Kilian says.
So how will rising gas prices be transmitted across the economy this time? Here's the math - an inverse of the "gas savings" exercise we did back in 2015: according to the Urban-Brookings Tax Policy Center, Americans will spend an average of $400 per household more on fuel this year than in 2016, as the rebound in crude prices is reflected in the cost of petrol at the pump. By contrast, middle-income US households will on average gain $930 each from the tax cut bill passed at the end of last year.
The problem is the non-homogeneous distribution of the middle class, and as the following table from Deutsche Bank shows, lower income households are hit far more by rising gas prices than they benefit from tax cuts, and vice versa on for high income households.
Another way of visualizing how the composition of spending by US consumers will be impacted, is shown in the chart below, which lays out the share of spending on gas as a portion of the total household budget.
What the chart above shows is that the hardest hit will be middle-income households. While cheaper oil handed a windfall to those households in the middle quintile, more than half of which was spent, now as much as half of that boost will be withdrawn.
As the FT further notes, rural households spent about 16% more on petrol on average than urban households in 2016. Fuel accounted for 4% of total household spending for middle-income Americans, but only 2.6% for the highest earning fifth.
And while the peak impact will be felt this summer when gasoline prices rise the most, there are already indications that higher fuel costs are having an adverse impact. US retail sales excluding fuel, food and cars have been mostly flat since November.
But while the US economy in general will lose, some will benefit: among them is the ongoing boom in are the various hotspots of the shale industry in places such as west Texas, where truck drivers are being hired for $100,000 per year, a boom which is funded by consumers.
So with higher prices, and potentially rising shale supply, will demand also be impacted? For now, few expects a drop-off in demand. According to an EIA forecast, petrol consumption is likely to be higher this summer than it was last year, although if there is one thing one can say with certainty about EIA predictions, is that they are almost always wrong.
“People aren’t going to start cancelling trips with gasoline at $2.75, and probably not at $2.95,” says Tom Kloza, head of research at Oil Price Information Service. “If the economy keeps chugging along, you’ll have to see more than 25 cents more on the price before you see a significant demand response.”
Ok, Tom, so at what price will people start canceling trips? And if travel plans remain, it means that spending on other, non-essential items - those which were expected to get a boost from the Trump tax cut - will be shelved.
The bottom line: anyone expecting a sharp bounce in US output, GDP and/or inflation, which in turn may prompt the Fed to hike taxes faster, will be disappointed.