Last month’s weak unemployment numbers, with only 120,000 jobs created, brought renewed wails that high oil prices were causing a recession.
Having heard this refrain so many times, I thought I'd dig a little deeper.
After all, a peak of $145 per barrel in the West Texas Intermediate oil price pretty well coincided with the onset of the 2008 recession.
The question is whether or not high oil prices are always correlated with an inevitable downturn.
For instance, when you look closer, oil was not to blame in 2008. Other factors were much more serious culprits, including the housing crisis (by then in market collapse) and the banking crisis that followed.
Between them they are the hallmarks of financial crisis that brought on the nasty recession.
To find out why, we need to do a little arithmetic.
High Oil Prices & the Economy
The US Bureau of Labor Statistics breaks down personal consumption expenditures (PCEs) on energy versus other items on a month-by-month basis.
The PCE on energy goods (which include natural gas and electricity) rose from 5.05% of total PCE in 2004 to 5.88% in 2007 and 6.31% in 2008. When oil prices peaked in July 2008 PCE hit a maximum monthly level of 7.01%.
Thus taking the increase from 2007 to the highest month in 2008, energy PCE rose by 1.13 % of total PCE, or about $115 billion on an annualized basis.
That sounds like a lot of money, but it's well under 1% of GDP.
For example, it's less than the estimated $152 billion cost of former President Bush's ineffective 2008 tax rebate stimulus.
Indeed, it is one-seventh the size of President Obama's stimulus the following year, which didn't have much visible effect. Thus the high oil prices of 2008 might have made the difference between marginal growth and marginal decline, which according to the "butterfly effect" of chaos theory could have caused other larger changes.
However, high oil prices were certainly not sufficient to push an otherwise healthy economy into recession.
2007 vs. 2012: Comparing High Oil Prices
This time, oil prices are rising from a higher base.
The average West Texas Intermediate oil price of $94.87 in 2011 was 31% above 2007's average. It follows that an oil price jump to $147 would not be very economically significant.
In this case, we would need a larger spike to have any noticeable effect.
Oil prices did spike 101% from 2007's average to the peak on July 3, 2008. A similar rise from 2011's average would take the price of oil to $191 per barrel.
If that jump raised energy PCE by the same proportion as in 2008 (starting from 2011's higher energy PCE of 6.07% of total PCE), it would push it up to 7.24% of PCE. This equates to a rise of about $129 billion.
If oil touched $200 a barrel, the rise in personal energy expenditures might be around $140 billion.
Again, at 0.9% of today's GDP that increase is just not big enough to cause recession in an economy growing even moderately.
It's just a little larger than the $118 billion "stimulus" from continuing the payroll tax cut for 2012.
It would slow growth, but given that we are currently experiencing growth of around 2%, it would not turn our current growth into decline.
With Federal Reserve Chairman Ben Bernanke's zero-interest-rate policies in place until 2014, and the chance of yet more "stimulus," it is indeed possible we will see oil at $200 per barrel.
The price could get there gradually, over the next 12-18 months, or it could leap there in one bound, if Iran closed the Straits of Hormuz. That would be very unpleasant, pushing gas prices up to $7 per gallon.
But the above calculation shows that on its own $200 oil would not push the US economy into recession.
Indeed, we should not expect it to; Europe has suffered from gas prices of $8 to $10 a gallon for several years now. While the European economy has many problems, it seems to survive its gas prices.
So we should expect to pay more for gas, but on balance should not expect recession from doing so.
As in 2008, the next recession is much more likely to be caused by the banking system.
About the Author
Martin Hutchinson is global investment strategist for Money Morning and a former merchant banker and market historian