Oil Price: RECOIL

Painful though it is, this oil shock will eventually spur huge change. Beware the hunt for scapegoats

IN THE early 1970s a fourfold rise in the price of oil almost brought the world to a standstill. The shock of the Arab embargo left a deep mark in many countries: America subjected its cars to fuel-efficiency standards, France embraced nuclear power—though sadly shoene rukku, or “energy-conscious fashion”, the inspiration for Japan's fetching short-sleeved business suit, was ahead of its time.

Thirty-five years on, oil prices have quadrupled again, briefly soaring to a peak of just over $135 a barrel. But, so far, this has been a slow-motion oil shock. If the Arab oil-weapon felt like a hammer-blow, this time stagnant oil output and growing emerging-market demand have squeezed the oil market like a vice. For almost five years a growing world shrugged it off. Only now is it recoiling in pain.

This week French fishermen clogged up the port of Dunkirk and British lorry-drivers choked roads into London and Cardiff. Nicolas Sarkozy, France's president, suggested subsidising the worst affected and curbing taxes on petrol; Britain's beleaguered government is being pressed to forgo its tax increases on motorists. In America falling house prices have left consumers resentful—and short of money. Congress and presidential candidates have been drafting schemes and gas-tax holidays like so many campaign leaflets.

Gordon Brown, Britain's prime minister, thinks the big oil producers can be persuaded to come to the rescue. But only Saudi Arabia shows any enthusiasm for that. Elsewhere, output is growing agonisingly slowly. That is causing hardship and recrimination. But it could also come to represent an opportunity. The slow-motion shock seems irresistible today, but in time it will give rise to an equally unstoppable and more positive slow-motion reaction (see article).

Action replay

It is clear that high oil prices are hurting many economies—especially in the rich world. Goldman Sachs reckons consumers are handing over $1.8 trillion a year to oil producers. The wage-price spiral of the 1970s has been avoided, but the income shock is painful. Beset by scarce credit, falling asset prices and costly food, developed-country households are hardly well-equipped to foot the oil bill. America's emergency tax rebate, voted this year to help people cope with the credit crunch, has in effect been taken right away again.

Stuck for answers, politicians have been looking for scapegoats. Top of the list are the speculators profiting from other people's hardship. Some $260 billion is invested in commodity funds, 20 times the level of 2003. Surely all that hot money has supercharged the demand for oil? But that is plain wrong. Such speculators do not own real oil. Every barrel they buy in the futures markets they sell back again before the contract ends. That may raise the price of “paper barrels”, but not of the black stuff refiners turn into petrol. It is true that high futures prices could lead someone to hoard oil today in the hope of a higher price tomorrow. But inventories are not especially full just now and there are few signs of hoarding.

If the speculators are not to blame, what about the oil companies, which have failed to increase output in spite of record profits? Profiteering, say some. However, that accusation doesn't stand up to much scrutiny either. The oil price is set in a market. For Shell, Exxon et al to hoard oil underground would be to leave billions of dollars of investment languishing unused. Others fear that oil is pricey because it is running out. But there is little evidence to support the doctrine of “peak oil” in its extreme form. The Middle East still seems to contain a sea of the stuff. Even if new finds elsewhere have been rarer and less accessible than in the past, vast quantities of oil could now be profitably stripped from tar sands and shale.

The truth is more prosaic. Finding and developing new oil fields is an expensive and time-consuming business. The giant new fields in the deep water off Brazil are unlikely to produce oil for a decade or more. Furthermore, oil is perverse. When prices are low, oil-rich countries welcome the low-cost, high-tech and well-capitalised oil firms. When prices are high, countries like Russia and Venezuela kick them out again. Likewise the engineers, survey ships and seismic rigs that oil firms need to find and produce new deposits are expensive right now. The costs of finding oil have, temporarily, doubled precisely because everybody wants to give them work.

Hope at the bottom of the barrel

So the oil shock will take time to abate. Some greens may welcome that, seeing three-figure oil as a way of limiting greenhouse emissions. Conservation will indeed increase. But everything high prices achieve could be done better by sensible carbon taxes. As well as curbing oil use, high prices have put tar sands in business which create far more carbon dioxide than conventional oil. Profits are going to ugly oil-fed regimes, not Western exchequers. And the wild unpredictability of prices will blunt the effect of dear oil on people's behaviour.

From this perspective, governments should speed up the adjustment—or at least stop delaying it. Half the world's people are sheltered from fuel prices by subsidies—which, perversely, have boosted demand and mostly benefited the better off. Now countries like Indonesia, Taiwan and Sri Lanka have begun to realise that they can ill afford this. Cutting fuel taxes in the rich world makes no sense either (see article). There are better ways to return cash to struggling voters.

The 1970s showed how demand and supply, inelastic in the short run, eventually give rise to conservation and new production. When all those new fields are on-stream, when the SUVs have been sold and the boilers replaced, the downcycle will take hold. By then the slow-motion oil shock could have catalysed momentous change. Right now motorists have no substitute for oil. But it is no coincidence that car companies are suddenly accelerating their plans to sell electric hybrids that are far cheaper to run than petrol or diesel cars at these prices. The first two oil shocks banished oil from power generation. How fitting if the third finished the job and began to free transport from oil's century-long monopoly.

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America's vulnerable economy

Recession in America looks increasingly likely. Can booming emerging markets save the world economy?

IN 1929, days after the stockmarket crash, the Harvard Economic Society reassured its subscribers: “A severe depression is outside the range of probability”. In a survey in March 2001, 95% of American economists said there would not be a recession, even though one had already started. Today, most economists do not forecast a recession in America, but the profession's pitiful forecasting record offers little comfort. Our latest assessment (see article) suggests that the United States may well be heading for recession.

Granted, GDP grew by a robust 3.9%, at an annual rate, in the third quarter. Granted also, revisions may well push this figure up. But that was the past. More timely signs suggest that the economy could stall in this quarter. By early next year, output and jobs could be shrinking. The main cause is the imploding housing market. Experts said that house prices could never fall nationwide. But fall they have, by 5% in the past 12 months. Residential investment has collapsed, but a glut of unsold homes means that prices have much further to drop. Americans' spending is likely to be dented much more by a fall in house prices than it was in 2001 by the stockmarket's collapse. With house prices lower and credit conditions tighter as a result of the subprime crisis, households can no longer borrow against capital gains to support their spending.

Dearer oil is set to squeeze households further (this week's drop in crude prices notwithstanding). Consumer confidence has already fallen sharply. It cannot be long before consumer spending stumbles, which in turn would hurt companies' profits and investment. The weak dollar will boost exports, but at only 12% of GDP, exports are too small to make up for a weakening of consumer spending, which accounts for 70%.

I want to break free

Will an American recession drag the rest of the world down with it? The economies of Europe and Japan rebounded strongly in the third quarter, but look likely to slow down. Although both should be able to keep chugging along, neither is likely to set any great pace. Strengthening currencies will hurt exporters in both places. Europe's own housing hotspots are cooling, and some of its banks have been sideswiped by America's subprime ills.

The best hope that global growth can stay strong lies instead with emerging economies. A decade ago, the thought that so much depended on these crisis-prone places would have been terrifying. Yet thanks largely to economic reforms, their annual growth rate has surged to around 7%. This year they will contribute half of the globe's GDP growth, measured at market exchange rates, over three times as much as America. In the past, emerging economies have often needed bailing out by the rich world. This time they could be the rescuers.

Of course, a recession in America would reduce emerging economies' exports, but they are less vulnerable than they used to be. America's importance as an engine of global growth has been exaggerated. Since 2000 its share of world imports has dropped from 19% to 14%. Its vast current-account deficit has started to shrink, meaning that America is no longer pulling along the rest of the world. Yet growth in emerging economies has quickened, partly thanks to demand at home. In the first half of this year the increase in consumer spending (in actual dollar terms) in China and India added more to global GDP growth than that in America.

Most emerging economies are in healthier shape than ever (see article). They are no longer financially dependent on the rest of the world, but have large foreign-exchange reserves—no less than three-quarters of the global total. Though there are some notable exceptions, most of them have small budget deficits (another change from the past), so they can boost spending to offset weaker exports if need be.

This does not mean emerging economies will grow fast enough to make up for the whole of a fall in America's output. Most of them will slow a bit next year: for instance, China's growth rate may dip to “only” 10%. So global growth will ease—which, after five years at an average of almost 5%, close to its fastest pace ever, it needs to do. But thanks to the vigour of the new titans, it will stay above its 30-year average of 3.5%.

A tale of two prices

The rising importance of the world's new giants will not only boost growth. It will also shift relative prices, notably those of oil and the dollar. And the consequences of this will be less comfortable for developed countries, especially America.

The oil price has risen mainly because of strong demand in emerging economies, which have accounted for as much as four-fifths of the total increase in oil consumption in the past five years. In past American recessions the oil price usually fell. This time it is likely to hold up. That will not only hurt the finances of Western consumers, but may also make the jobs of their central bankers harder, by combining inflationary pressure with economic slowdown.

The enfeebled dollar—lately in sight of $1.50 to the euro—would be weaker still without enormous purchases by central banks in emerging economies. This support is now waning. China and others are putting a smaller share of increases in reserves into the American currency. And Asian and Middle Eastern countries with currencies linked to the dollar are facing rising inflation, but falling American interest rates make it harder to tighten their own monetary policy. They may have to let their currencies rise against the sickly greenback, meaning they will need to buy fewer dollars. More important, as international investors wake up to the relative weakening of America's economic power, they will surely question why they hold the bulk of their wealth in dollars. The dollar's decline already amounts to the biggest default in history, having wiped far more off the value of foreigners' assets than any emerging market has ever done.

The vigour of emerging economies is good news for the world economy: for its growth, it has much less need of a strong America. The bad news for America is that this, in turn, may mean that the world also has less need of the dollar.