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Archive for Monday, August 23, 2004

Oil prices could spark new recession

August 23, 2004

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— High oil prices, which have been a factor in virtually all U.S. recessions over the past three decades, are surging again this year. And the higher crude oil prices climb, the more risk energy costs pose to what, until recently, many expected to be a banner year for the U.S. economy.

Some economists are even beginning to worry about an outright recession if oil prices, already at record levels, go much higher. And concerns are rising about the threat of "stagflation," a dreaded economic malady of stagnant growth coupled with rising prices that had the United States in its grip during the oil shocks of the 1970s.

It isn't just higher energy prices that are inflicting the damage, but the ripple effect these higher costs have on such critical areas as consumer spending.

"Oil has become a barometer of confidence in the global economy," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis. "Higher oil prices mean uncertainty is rising and economic growth is going to be weaker."

Stock prices, which have been buffeted by the surge in oil prices over the past few weeks, recovered a bit Friday with the Dow Jones industrial average rising 69.32 points to 10,110.14. Investors were heartened that oil prices, which had been setting a string of record highs, retreated Friday to close at $47.60, down $1.10 from an all-time high of $48.70 set Thursday.

The Iraq impact

Many analysts believe the U.S. economy could still be jolted by oil prices above $50 per barrel with all the lingering concerns about possible supply disruptions in Iraq and elsewhere.

"If you look at what is going on in the economy, there is a lot to make you nervous," said David Wyss, chief economist at Standard & Poor's in New York.

Those concerns have caused analysts to trim their forecasts for economic growth in recent weeks. A quarterly survey of 30 top economists done by the Federal Reserve Bank of Philadelphia found them forecasting growth of 4.3 percent this year, down from their estimate three months ago of 4.6 percent growth, which would have been the strongest pace in 20 years.

Natural gas burns after insurgents bomb an oil pipeline in southern
Iraq. It had been closed the week prior to Saturday's attack
because of threats. It was unclear what effect the bombing would
have on oil exports after prices dropped Friday. Many analysts
believe the U.S. economy could still be jolted by oil prices above
$50 per barrel with all the lingering concerns about possible
supply disruptions in Iraq and elsewhere.

Natural gas burns after insurgents bomb an oil pipeline in southern Iraq. It had been closed the week prior to Saturday's attack because of threats. It was unclear what effect the bombing would have on oil exports after prices dropped Friday. Many analysts believe the U.S. economy could still be jolted by oil prices above $50 per barrel with all the lingering concerns about possible supply disruptions in Iraq and elsewhere.

The 4.3 percent forecast for the gross domestic product would still be faster than the 3 percent gain of 2003, but it would be slower than the 4.5 percent growth rates hit in both 1999 and 1997 during the United States' record-breaking, decadelong economic expansion.

Some pessimists are slashing their forecasts even more. Stephen Roach, chief economist at Morgan Stanley, notified clients last week that if oil prices remained around present levels they "could lead to a recession in 2005."

The rise in energy costs since early this year has already exacted a toll. The gross domestic product, which was racing ahead at a 4.5 percent rate in the first three months of this year, slowed to a 3 percent pace in the April-June quarter as consumers cut back sharply on spending.

John Felmy, chief economist at the American Petroleum Institute, an industry group in Washington, calculates that two-thirds of that slowdown can be attributed to higher energy prices.

That slower growth and rising anxiety over energy prices caused businesses to cut back sharply on hiring over the past two months, with just 32,000 jobs created in July, far below the 200,000-plus jobs analysts had been expecting.

'Terror premium'

Many economists believe oil prices at current levels are carrying as much as a $15 "terror premium" reflecting investors' worries about future supply disruptions at a time when global demand, led by China, is surging. If the situation in Iraq settles down, these analysts think oil prices could retreat again to more moderate levels around $35 per barrel.

Even at the current elevated levels, analysts say the economy is strong enough to achieve a growth rate of slightly higher than 4 percent this year and around 3.7 percent in 2005. That pace would be strong enough to keep the unemployment rate, currently at 5.5 percent, heading down to 5.2 percent by the end of next year, according to the economists surveyed by the Philadelphia Fed.

"We will be growing even at these higher oil prices, just not as fast as we had been expecting," said Nariman Behravesh, chief economist at Global Insight.

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