Did the Oil Price Boom of 2008 Cause the Recession?

[steven johnson]

The 'Real Time Economics' blog by Justin Lahart in the Wall Street Journal, 4/3/09, had a provocative discussion of a Brookings Institute paper attributing nearly all of last year’s economic downturn to the oil price shock.

In part it says:

Reeling from the housing bust and the banking crisis, it’s hard to think that the energy shock — the one that carried the average price of gasoline to a peak of $4.11 a gallon last July — was much more than a minor player in the economic downturn. But there’s the uncomfortable fact previous oil shocks, like the ones that came with the 1973 oil embargo, the 1979 Iranian revolution and the 1990 invasion of Kuwait, were also associated with recessions. And the 2001 recession, too, came on the heels of a run-up in oil prices.

In a paper presented at the Brookings Panel on Economic Activity Thursday, University of Calif.-San Diego economist James Hamilton crunched some numbers on how consumer spending responds to rising energy prices and came to a surprising result: Nearly all of last year’s economic downturn could be attributed to the oil price shock.

As he writes on his blog, that’s a conclusion that he doesn’t quite believe in himself. We’d like to think that, say, the seizing up of the credit markets this fall had something to with the economy falling off the table in the fourth quarter.

But then again, maybe what happened to oil prices had something to do with credit markets seizing up. The housing bubble saw people of lesser means traveling further afield to buy homes. That gave them long commutes that they were able to afford when gas was $2 a gallon, but maybe they couldn’t at $3.

http://blogs.wsj.com/economics/2009/04/03/did-the-oil-price-boom-of-2008-cause-crisis/

http://pzl1.ed.ornl.gov/IAEE_2002_oil_macro_paper_rev2.pdf

The disconcerting implication is that if oil production peaks and starts to decline as many predict it will, there will be severe consequences by 2050:

In 2050 the size of the upper and middle classes remains almost constant, while the number of poor balloons to two and a half times its current level.. Even worse, the average per capita GDP of the poor group drops from $2,900 today to $1,500 in 2050, a drop of almost 50%. This is due to the burgeoning population of this group sharing the shrinking energy pie. Another significant factor is the movement of a number of large and growing countries from the from the middle class to the poor group.

In sharp contrast to the outcomes expected for the rich countries, poor nations face a decidedly bleak future in 2050. The number of poor nations or regions jumps from 5 to 18. The total population of the group more than doubles while the average per capita GDP for the group drops by half. Given the level of human misery that exists in the poor nations today, this is a decidedly ominous forecast.

By 2050 well over half the world's population will be desperately, abjectly poor, and even the rich will find themselves living in constrained circumstances as their average per capita income drops by 25%. Just at the time when foreign aid is most desperately needed, the nations that will be called on to supply it will be find themselves less able to deliver. The implications for life and death in the poverty-stricken regions are dire indeed.

http://canada.theoildrum.com/node/3230

[Uben]

1. That's not what got my money

I paid more for gas, sure, but the bulk of my losses were in the market, and we know that was a direct result of credit default swaps by greedy assed bankers and traders. I'm still pissed they weren't lined up, blindfolded and shot dead! I hate fucking thieves. Anyone who steals from others, no matter what venue they chose, are useless to the human race and need to be eliminated.
They had a choice......and they made the wrong one....now they must pay! Sorry, that's the way I feel. I've spent 54 years tryin to be an honest law abiding citizen, all the while trying to work hard to achieve the American dream. Those who game the system think they are sly, but they are just pieces of shit circling the commode.

[Jackpine Radical]

7. I think the gas price balloon unmasked the Ponzi schemes in the market.

By sucking the spare cash out of the system, the gas companies left nothing for the suckers to keep investing, and without the investments rolling in, the gaming of the market became all too visible.

[cosmik debris]

2. I believe the recession started in the 4th quarter of '07. n/t

[steven johnson]

4. Exactly, which makes this the longest recession in recent history

Unfortunately, Richard Marcus and Paul Kasriel are both predicting prolonged double-dip recession:

So, prepare for an unsettling elongated recession, one that in total length is over two years in duration even if split up into two successive recesions. While a masive federal stimulus may show a temporary upward blip in economic activity in late spring, the path this year is a protracted slide down a long road of bad employment and worsening unempolyment news.

http://www.uwm.edu/~marcus/Outlook2009.pdf

So, what is our rationale for a late-2009 economic recovery and a subsequent 2011 or 2012 slowdown/downturn? Massive federal spending funded by the Federal Reserve and the banking system. The Obama administration and Congress are in the process of developing a two-year fiscal stimulus package that at last, but likely not the final, count totals $825 billion. This fiscal stimulus program will include all things to all people - traditional and non-traditional infrastructure spending, aid to state and local governments, expansion of food stamp and unemployment insurance programs, and tax cuts for households and businesses. This massive federal spending and tax cut program will be financed by issuing additional federal debt. Who is likely to purchase this debt? The Federal Reserve and the banking system.

The implication of the banking system and the Federal Reserve monetizing large proportions of nonfinancial sector borrowing - government or private sector - is that the borrowers are able to increase their spending without any other entity cutting back on its spending. Thus, in terms of the GDP accounts, total spending in the economy increases. This is why we expect a recovery in real GDP by the fourth quarter of this year.

If monetizing nonfinancial debt were costless, economically speaking, the Zimbabwean economy would be the envy of the world. But, of course, there are economic costs. Monetizing debt means printing money. And printing money ultimately leads to accelerating prices - prices of goods, services and assets. As well intentioned as it may be, the government does not use economic resources as efficiently as the private sector. This inefficiency from government spending worsens the trade-off between aggregate demand and goods/services price increases.

In conclusion, over much of 2009, the year-over-year change in the CPI is likely to be negative. We advise investors not to extrapolate this "deflation" into 2010 and 2011. With the massive monetization of debt that is likely to occur, increases in the CPI are expected to resume.


http://www.marketoracle.co.uk/Article8444.html

[Po_d Mainiac]

3. IMHO, That's a weak argument

Systemic fraud in the housing, banking and financial markets have caused the depression. It was going to happen no matter what.
The price of oil had a lot to do with the timing of the bust, but was far from the cause.

[wuvuj]

6. Check the Oil Drum?

http://www.theoildrum.com/node/5230#more

Some make the case that it's all tied together...which in the real world...it all is.

A lot of the speculation in oil futures was being done by the same people speculating in CDOs?

With an ever increasing population...and diminishing resources...I doubt if things will get back to what was "normal" for a good while....meaning NEVER.


Take the course?

http://www.chrismartenson.com/crashcourse

[Po_d Mainiac]

17. Do not confuse the current implosion

With the one pending. That being when the drum empties. :nuke:

Different problems with similar severe/dire implications.

[wuvuj]

20. The current crisis...

...is just a small taste of what's to come?

Relying on ever increasing debt is related to higher consumption of energy...speculating in energy futures also is related to margin levels (debt).

They have no solutions other than continual economic growth....i. e. growing debt. No real attempt to limit population growth. Increasing police state techniques and technology. There is only one way it is going to end...badly.

[Jackpine Radical]

8. Yes, that's right.

[HillbillyBob]

5. I know the cost of fuel really socked our budget, to the point

that we could not do the things we had budgeted for on our little farm, that left equipment, plants and projects to bring the house up to code undone. In the end we wasted money on energy that we could have saved if we had been able to afford to do our green projects. The money for the projects went to fuel to get work, fuel for farm equiment, and power for the house.
I have no sympathy for the corporations, the auto makers who have known for 40 years that peak oil was coming but they still built fuel sucking hogs that fall apart fast, and the loan sharking industry that our banks have become.
I di have sympathy for the lower ranks in those companies who have no control over how the socalled managers screwed us all over.

[zbdent]

9. so, if the $4/gallon gas caused the recession ... why isn't $2/gallong gas

(what it was before the recession) causing prosperity?

[Trajan]

10. Bush, Cheney and their oil baron friends certainly took advantage ...

and raked the world with inflated oil prices, saddling every tier in the marketplace with increased energy costs - Making them VERY rich while forcing everyone else to absorb the added expenses across the board ....

Food and energy costs were directly impacted, which cut into family budgets across the board, while at the same time, housing was either too expensive (on the way up) or a bust as the market tanked ...

Anyway you look at it: energy costs took a larger piece of the stagnant wage pie, which made it less likely for families to be able to make purchases of other non food, non energy goods and services ... It also made it less likely they could pay their mortgage, since 'extra' monies were being absorbed to pay Exxon and Texaco more for their energy ....

We might say that gouging at the oil well robbed consumers of the ability to contribute to overall economic activity, reducing sales across the board, and causing ALL businesses to experience lower revenues and diminishing profits, which forced them to consider reducing their workforce in response ...

Yeah .... I do believe the outrageous escalation of oil prices during the last few years had a direct effect on the economy, and should be considered one of the root causes ...

[azul]

11. Yes part of the cause. But I think the high prices were a set-up

to sabotage the alternative energy investments so that any possible competitors to the oil energy domination of the economy would be bankrupted and made to look like risky and ill-conceived failings.

The oil industry may have shot itself in the rear, however, because the timing of the high prices with the mortgage debt problems knocked the world into a recession and people really started to use less oil. Plus the writing is on the wall as to the direction of oil prices and wild fluctuations and alternatives look better and better.

[HamdenRice]

12. Finally someone stated the obvious

I'm kind of shocked that no economist had studied this before and come to this conclusion. There were underlying problems in the mortgage market, but it was the oil price shock that burst the bubble.

[JohnWxy]

13. The commodities price bubble was part of the same Deregulation bomb - Credit Default Swaps legalized

by the Commodity Futures Modernization Act (sponsor: Phil Gramm). Yes, Credit Default Swaps enabled the massive participation by institutional investors which produced the enormous increase in speculation in commodities from 2002 to 2008 (speculative dollars committed grew 22 times from end of 2003 to March 2008). See Michael Masters testimony before Congress on this commodity speculation.

"Index Speculators are pouring billions of dollars into the commodities futures markets, speculating that commodity prices will increase. Chart One shows Assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008!"

The CFMA made possible was use of CDSs to speculate in commodities through investment banks (who sold the institutions the CDSs to cover their speculation in the commodities and thus, in effect, protect them from total loss of their money. Obviouosly, this lead to much greater speculation in commodities as the speculators felt their risk of complete loss was practically eliminated! Plus, thanks to the CFMA speculating in commodities when done throuugh investment banks was not regulated or monitored and there were NO POSITION LIMITS IMPOSED on commodity speculators.

From Michael Masters:

"The CFTC has granted Wall Street banks an exemption from speculative position limits when these banks hedge over-the-counter swaps transactions (i.e Credit Default Swaps __JW).21 This has effectively opened a loophole for unlimited speculation. When Index Speculators enter into commodity index swaps, which 85-90% of them do, they face no speculative position limits."


THIS IS A PRESCRIPTION FOR DISASTER.


NOte that not just Oil shot up from Sept. 2007 to June 2008. Grains like corn, wheat and soy went up just as much as oil did. NOte that grain price increases produced food price increases - around the world.


Perhaps no one person has created so much economic destruction as Phil Gramm (Foreclosure Phil) with his simplistic belief in deregulation.

[tama]

14. The last nail in the coffin

By all the evidence available conventional (cheap) oil peaked in 2005 - even though oil prices grew exponentially, production of conventional oil stayed flat or went down a little.

But far more fundamental peak happened allready in 1979 when global oil prodaction per capita peaked. What has economy based on since that? Wages and purchasing power has stayed flat or gone down and consumerism has been increasingly based on debt. Eating the future of our children.

[girl gone mad]

15. James Hamilton also wrote about it on his blog.

Here's his paper:

http://www.brookings.edu/economics/bpea/~/media/Files/Programs/ES/BPEA/2009_spring_bpea_papers/2009_spring_bpea_hamilton.pdf

And his blog:

http://www.econbrowser.com/

The discussion there on this topic has been pretty good:

http://www.econbrowser.com/archives/2009/04/causes_of_the_o.html

Very interesting!

[sendero]

16. No....

.... and it is ludicrous to think so.

[upi402]

18. Oil Windfall Profit Tax at 99%

would give me some hope.

[depakid]

19. "...severe consequences by 2050?"

Try 2015.

[GliderGuider]

21. In that Oil Drum article I failed to account for the brittleness of the global economy.

Even with all its dire predictions, the article is based on "ceteris paribus" assumptions for everything except energy. Because of that shortcoming it presents far too rosy a picture of the state of the world in 2050 (as evidenced by the fact that the situation is already far worse than anyone expected).

The underlying problem as I understand it now is that the global economy is a very complex system that is highly interdependent and very efficient. That efficiency is part of its undoing, as it introduces many single points of failure into the system. As a result the system has become extremely brittle -- relatively small shocks (like an oil price spike) that could have been buffered in a more redundant system cause failure cascades. I believe this is precisely what we've seen over the last year.

My biggest concern is that with the oil supply now constrained and with insufficient investment in alternative energy (as a result of the economic crash) any attempt at economic recovery will be knocked flat by repeated oil price spikes.

Of course if I had included such assessments in that article in 2007 everyone would have called me a Chicken Little...

[tama]

22. Wall-Martism

Logistics pushed to the edge of "efficiency" - efficiency that is totally dependent on cheap and available transportation which is dependent on cheap fuel.

System of logistics so "efficient" that if (and when?) it brakes down, supermarkets will be empty and starvation will start in 48 hours...

But that's a caricature of a "worst case scenario" - the system has multiple fractures, widening all the time, the dam bursting is not a singular television moment but slow motion, happening all the time.

But, the quicker it happens and the sooner a new beginning begins, the less it will hurt.