John Rapley
THE PRICE of oil on world markets moves ever higher, reaching levels never before seen. Now in the US$65-per-barrel range, it is expected by most industry analysts to rise further yet. We may well see a barrel of oil in the 70s before long.
If it just keeps on going after that, it may bump up against an all-time high. While the nominal price of oil is higher than it has ever been, once adjusted for inflation, it remains below the levels set in the early 1980s. But that target, in the low $80-range, is coming within reach.
Assuming prices go higher and stay higher, the global economy will feel the impact. True, the world has changed a good deal since the last major oil shocks of the 1970s. In particular, the industrial economies have become a good deal more efficient. As a result, another oil shock is unlikely, on its own, to plunge the world economy into recession.
But unless oil prices come back down, a slowdown is inevitable. U.S. financial markets appear to have already priced such an outcome into asset values. Apparently, investors are betting that high prices at the gas pump will eventually slow down the U.S. economy, which will in turn reduce demand pressures and keep a lid on inflation.
However, a curious paradox results from this psychology. Confident as they are that a slowdown is on its way, investors are keeping interest rates down. But low interest rates are encouraging American consumers to spend. As they spend, the economy stays healthy. That means Americans keep buying lots of Chinese goods.
That, in turn, means the Chinese economy - and indeed th rest of th global economy - keeps swimming along. Factories keep operating around the clock, sucking up lots of energy, and thus keeping demand for oil strong.
Sooner or later, something has got to give. There are three possible outcomes. The first is that high oil prices will eventually slow global growth. The second is that global growth will continue as it has, and inflation will rise. Of these two possibilities, the first is probably more desirable. While continued strong growth is good in the short term, rising inflation would drive up interest rates. Rising interest rates, in turn, could burst the housing bubble in the U.S., and indeed much of the world. That could eventually bring on a deeper and longer slowdown.
RELENTLESS SURGE
There is, of course, a third possibility. That is that oil prices will fall again. Their relentless surge is something of an enigma, because the high price of oil apparently confounds the fundamentals of the market. The global oil supply is actually sufficient to meet demand. Stocks are rising, and the high price is encouraging oil companies to sink more wells. This will eventually add further to supply. Indeed, some analysts are forecasting that a crash in oil prices remains a possibility down the road.
Why, then, do prices keep driving higher? Short-term concerns appear to be weighing heavily on the market. The Middle East, from whence so much supply comes, remains volatile. The Iraq war shows no signs of letting up. Saudi Arabia is in a delicate situation, especially in light of the transition to a new king. Iran's new president is planning to resume the country's nuclear programme, putting it on a possible collision course with the U.S.
Taken all together, these factors suggest that prices are likely to remain high for the time being. Most analysts are suggesting that while relief may come next year, the short-term prognosis is for more price rises. World oil prices may remain strong largely because of China's rapid growth. But they sure aren't doing much for ours.
John Rapley is senior lecturer in the Department of Government at the University of the West Indies, Mona.
