Will $100 Oil Kill the Recovery?

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Oil climb has traders and others saying oh-no (Photo: Reuters/Brendan McDermid)

Here’s something you never hear: Oil caused the financial crisis. Back when the Financial Crisis Inquiry Commission started a year and a half ago, they had 22 things they were looking into. Oil didn’t even make the list. And why not? On the surface it’s just as reasonable as the rest. Oil prices shot up during 2007 and 2008. Higher gas prices made it harder for Americans to pay their bills, most importantly their mortgages. Loans went bad. Foreclosures shot up. House prices tumbled. The rest is history.

And yet. That’s not how anyone remembers it. Oil isn’t really even in the conversation.

If you don’t know why I am bringing this up now, you haven’t been watching the news. The unrest in the Middle East, which has spread to oil-rich Libya, has caused crude prices to spike. On Wednesday, oil hit $100 a barrel for the first time since the financial crisis. It ended the day at around $98. Still, the $100 mark is a psychological one. And the fact that oil has marched back to that level so fast while so many people are still out of work, has some concerned. But oil is rarely a recovery killer, and probably won’t be this time either. Here’s why:

Every recovery, has oil worry. The issue it seems is that when gas prices rise that leaves people with less money to pay for other things. They consume less. And the economy suffers. And that happens, but the question is how much. I remember when oil hit $50 a barrel in 2005 market forecasters began worrying that rising gas prices would kill the mid-2000s recovery. But it didn’t, we headed straight into the housing bubble. Hurray.

What many analysts miss is that while it seems like we are always filling up the tank, gas really only makes up a small part of our budget. Americans spent just 4% of their paychecks on gas in 2009, which is the latest figures I could find quickly. That means oil has to really jump before it slows spending on all the other stuff. What’s more, even when gas prices rise there are ways we can deal with it. We can drive less. We can take public transportation. We can buy smaller cars. We can start using that smaller car we bought back in 2008 again. Not all of those things are possible for everyone, but the point is there are ways to mitigate the rising cost of gas on the budget.

But there is the psychological factor. Some are saying that if gas prices get to $4 a gallon, consumer confidence will plunge. And that might have been true a decade ago. But we have lived with higher gas prices for a time. Paying $100 to fill up your tank is painful, but it’s not as freakout inducing as it once was. People adjust their expectations. So I don’t think $4 a gallon gas means people won’t travel this summer, or even less.

What’s more, higher oil prices have some positive effects on the economy, and already are. One of the other recovery killers that people have been worried about is rising interest rates. But the recent increase in oil has caused bonds to trade up, and interest rates to fall. Yes, that’s because some investors are worried about the economy, but a dip in interest rates is welcomed news nonetheless. The dollar fell as well, and a weaker dollar should continue to boost our already rising exports.

Yes, the oil price rise is only one of a number of commodities that are jumping in price. And all that will hurt profits for manufacturing companies. But the US economy relies less on manufacturing that it used to, even with rising exports. And with corporate profits rising rapidly, companies can afford to spend a little more on raw goods, before they have to raise prices. What’s more, the biggest cost for corporate America is labor, and wages aren’t expected to rise significantly anytime soon.

That’s not to say that there isn’t a price of oil at which the economy would suffer. But we are not there yet:

Some economists say the rise in oil prices has been relatively gradual, easing their effect on growth. In a Wall Street Journal survey published last week, some economists said prices on average would need to jump to about $127 a barrel to bring down growth.

“There’s been a gradual change to move toward $100, and that’s very, very important for adjustments in consumer behavior,” said Amrita Sen, an analyst in London with Barclays Capital, a unit of Barclays PLC. “Because there’s been such a gradual change in prices, people have adjusted to it.”

There is a balancing mechanism in every recovery. Things pop up, like interest rates, and everyone starts saying the recovery is over. Then something else pops up, like oil, to neutralize the first thing, and everyone starts worrying about that. In truth, recoveries are very hard to stop. They have amazing momentum, even if slower than we would like.