Are Fast-Rising Oil Prices Economy-Killers?

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Are Fast-Rising Oil Prices Economy-Killers? Reuters - 9/2/00 2:07:00 PM

By Pierre Belec

NEW YORK (Reuters) - Is it fair to call soaring oil prices economy-killers? Some experts say yes, yet Wall Street has been relaxed about the explosion in oil prices and the prospect that energy may be a expensive item for a long time.

Indeed, this year's surge in crude oil prices to a 10-year high has changed the inflation script. Gasoline prices at the pump reached record levels this summer and heating oil and natural gas prices are forecast to go through the roof this winter.

With the stock market chugging along nicely, investors seem to be hoping that the economy will be miraculously lucky in avoiding the nasties from oil's spike.

Something else has changed. The interest-rate environment is no longer as favorable, now that the Federal Reserve has pushed up the cost of borrowing by 1.75 percentage points to a nine-year high. The central bank's goal is to zap consumer spending, which has powered the economy's expansion to a record 10th year. The concern is that such long-running growth could spark a cycle of inflation.

Faced with this new economic landscape, the Nervous Nellies say higher interest rates and oil prices are a bad mix that may slam the economy.

``We remain concerned that rising energy prices will spill over into non-energy prices, raising core consumer price inflation and the need for higher interest rates,'' says Gail Dudack, chief investment strategist for UBS Warburg.

RIGHT OR WRONG? CHECK IT OUT.

``Certainly, higher interest rates, higher energy costs and slower job growth suggest that the economy cannot keep up its previous pace,'' says Allen Sinai, chief global economist for Primark Decision Economics Inc.

``The 175-basis-point increase of short-term interest rates (by the Fed) and $75 billion to $100 billion equivalent tax hike from higher energy prices must slow the economy. But how much so is not clear,'' he said.

Others cited the psychological negative that soaring energy prices will have on the consumer and producer price indexes through year-end.

With the PPI and CPI trending higher, the bigger the odds of more interest-rate increases as inflation-fighting Alan Greenspan, the Fed chairman, turns up the noise about the damage that escalating oil prices will have on the economy.

GOODBYE TO ERA OF ULTRA-LOW INFLATION

``You'd never know there was a crisis on Wall Street,'' says Stephen Leeb, editor of Personal Finance, a financial newsletter. ``Like the rest of America, the investment community thinks the high price of energy is just temporary. Prices are not going to come down. In fact, they are going to continue to soar.''

Oil prices have more than tripled since February 1999, climbing from an unusually depressed $10 to more than $30 a barrel.

Heating oil prices galloped to a 10-year high this week and now stand at twice the level of the winter of 1999, at more than $1 a gallon.

There's more bad news for heating oil customers. Abnormally low supplies will keep upward pressure on prices. U.S. heating oil stocks are down 39 percent from a year ago and in the Northeast, the world's largest heating oil market, reserves have plunged to 20 million barrels from 45 million in 1999, according to the American Petroleum Institute.

In another twist of 'Our gain is your pain' theme, U.S. producers of heating oil are shipping heating oil to Europe because prices are higher on the Continent.

Natural gas producers, meanwhile, are asking state regulators for double-digit price increases with natgas already costing more than twice as much as a year ago.

The summer wasn't a walk in the park for the automobile-dependent Americans. Gasoline prices climbed to a record high of more than $2 a gallon in some areas of the country. After a two-month slide, gasoline prices are again climbing because of skyrocketing oil prices.

FAIR TO GIVE ENERGY PRICES AN ECONOMY-KILLER STATUS?

``Most economists have too short of a memory -- or they don't have one because they did not live through it -- but the last period of hyper-inflation in 1974 was started by rising energy prices, which crept into all other goods and services,'' says Ned Riley, chief investment strategist for State Street Global Advisors in Boston.

``Back then, most people excused away the inflation pressure because it was energy-related and clearly OPEC was going to break down and crumble and we would not have an inflation problem,'' he said.

``Inflation peaked around 1980 and it showed that it was not a short-lived thing, but rather a quite significant period of protracted rising prices and wages catching up with the cost of buying goods,'' Riley said.

Rising energy prices also caused or aggravated recessions in the 1980s and 1990s.

For the last half-decade, cheap oil may have boosted global economic growth by keeping inflation low. But the great times came to an end in the spring of 1998, when the Organization of Petroleum Exporting Countries, known for its lack of discipline, finally got its act together and started cutting back on supplies.

The concern now is that the global economy may be seeing the start of a fundamental change in the oil market. If so, energy costs may stay high for a long time, or until OPEC infighting starts again, or a global recession causes the world to gag on excess oil production.

Meanwhile, U.S. inflation gauges have been mysteriously tame this summer, despite record gasoline prices. But the impact of fast-rising oil prices may take up to 1-1/2 years to fully snake through the economy.

Sinai said Greenspan does not have as much elbow room as in 1999, when inflation was missing from the radar screen.

Last year, the core rate of inflation, which excludes the wildly fluctuating food and energy prices, edged up just 1.5 percent -- under the Fed's tolerance of 2.0 percent. This year, the core rate has risen to 2.5 percent.

``Any ratcheting-up from here would put the Federal Reserve in a very difficult position in terms of maintaining price level stability, which is the Fed's stated goal,'' Sinai said.

The explosion in energy prices may be more damaging to the economies of other industrialized countries because they pay for oil in U.S. dollars, which is a currency that is strong against the weak euro.

Yet some experts say energy prices are not as much of a factor in this 'New Economy' because technology has transformed how business is done. In other words, technology has rendered historical inflation extinct.

Others disagree. In 1990, when Iraq invaded Kuwait, oil doubled to more than $40 a barrel and U.S. inflation shot up to more than 6 percent from 4.6 percent in 1989.

Ten years later, can the ``Great Technology Revolution'' have so radically changed the way the economy works that it will be immune to leaping oil prices?

That seems to be the hope on Wall Street.

http://www.stockhouse.com/news/viewstory.asp?id=370818



-- Martin Thompson (mthom1927@aol.com), September 03, 2000


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