Oil prices have risen steadily since the situation in the Middle East began deteriorating. So even if they stay where they are, this represents a
serious shock to the system — and there could be more to come.
Economists have never reached a consensus about what happened in 1979, but my interpretation is that it was similar to the recent California
electricity crisis. In both cases the key was the combination of a tight market and demand that wasn't very responsive to price. Under those
circumstances, individual producers — power companies in California, oil-producing countries in 1979 — have a lot of market power. That is, it is in
each producer's interest to cut back production to drive prices higher. The result is a price surge, even though there is no real capacity
The point is that markets are so tight that the logic of market power kicks in and countries decide that, quite aside from politics, their financial
interest lies in reducing, not increasing, their output. The Saudis 10% increase is nothing more than a fart in the back of the classroom.
If an oil crisis can happen so easily, why haven't we had one since 1979? The answer is that we made ourselves crisis-proof for a while, then became
complacent. After the oil crises of the 1970's, Western economies sharply increased their energy efficiency: the U.S. economy was a third bigger in
1985 than it was in 1973, but it consumed less oil. The result was the marginalization of the danger zone: in 1985, the Persian Gulf produced only 18
percent of the world's oil, less than half of its share in 1973. But rapidly growing oil consumption in the S.U.V. era was met, inevitably, by
increased Persian Gulf production. So oil prices are once again hostage to Middle Eastern politics.
Today, after a decade of price stability, fears of inflation are much more muted. Instead, the main concern is the drag of oil prices on purchasing
power. Each $10-per-barrel increase in the price of oil is like a $70 billion tax increase, one that falls most heavily on middle- and lower-income
And this is not a good time to slash purchasing power. Business investment, which plunged last year, has still not recovered; optimistic economic
forecasts depend on the assumption that buoyant consumer spending will keep the economy afloat until businesses do decide to invest again. If
consumers are made poorer by higher oil prices and cut back instead, that assumption goes out the window. And the Fed can't respond with another big
round of interest rate cuts: since it has already reduced rates from 6.5 to practically nothing, it doesn't have much ammunition left.
We've had our economy buoyed by nothing much more than consumer spending, housing & military purchases by the Fed. Only one of those 3 is unaffected
by depleted purchasing power due to higher oil prices. Those two that are? Well, don't forget that they are also impacted by droughts, which drive up
food costs ( $3.80 for milk!?! ) and the states making due with a litany of taxes to compensate for what the Fed is not providing.
What did the Irishman say to Braveheart again!??!?!
[Edited on 3-6-2004 by Bout Time]