LONDON (ResourceInvestor.com) -- Stagflation is an ugly word, and one that hasn’t been bandied about too much since the 1970s. But today, people are saying it a lot.
And quite rightly too, given that the threat of recession is now stalking the U.S. and some of the other industrial economies, the U.K. probably being the next most vulnerable thanks to a housing bubble that is even more severe than that observable in the U.S. Yet oil prices remain stubbornly high.
Inflation is already on the rise thanks to an environment of rising commodity prices more or less across the board and, in the U.S., a weakening currency. It is arguable that inflation in the industrial nations was only ever considered to be in abeyance because the re-entry of China into the world economy was holding down the price of manufactured goods to such a large extent. But that seems to be at an end.
High oil prices couldn’t be blamed for causing a recession this year, although they certainly don’t help. The industrialised economies have fortunately become much less sensitive to the price of oil since the price shocks of the 1970s/80s last got people talking about stagflation.
The problem now is that demand is growing to such an extent that prices are likely to stay high in the face of any conceivable decline in world economic activity.
So we could end up, in some economies, with stagnant growth and high inflation – stagflation.
That said, while there may be a recession in the U.S. this year, there is unlikely to be a recession in China, where new cars are coming onto new roads at staggering rates and air travel is growing enormously, so China’s demand for oil will continue to grow. Economic growth elsewhere is also contributing to extremely solid demand for the black stuff.
At the same time, many members of OPEC, the cartel of producers that retains a great deal of power in the oil market, even if it no longer represents the majority of world production, have become addicted to the high oil price.
The rise in the oil price that has taken place since the turn of the century has given some of these countries a relevance they could never before have dreamt of and many of their citizens a lifestyle they could never have achieved if oil prices had stayed as they were in the 1990s.
So it seems that despite calls to make more supply available, OPEC will not do so to the extent that would be required to meaningfully lower oil prices - even if its producing capacity allowed it to.
Geopolitical risk also has an appreciable impact on the oil price. The war in Iraq, festering discord with Iran and the recalcitrance of Venezuela - all spring to mind as major sources of risk.
Venezuela’s President Hugo Chavez recently threatened to end all oil shipments to the U.S. in response to legal action against Venezuela by U.S. oil major ExxonMobil [NYSE:XOM]. And he might just be crazy enough to do it, despite a recent admission from a Venezuelan government official that such an act would “hurt both nations”.
With major issues like these unresolved, the world seems to be getting riskier as far as the oil market is concerned, which is likely to make a large risk premium a feature of the oil price that is here to stay for some time.
Will there be a U.S. recession? It would be nice to think that aggressive action by the Federal Reserve and strong economic growth outside the U.S. will be enough to avert disaster. But factors such as the falling housing market, the weakening greenback and a financial system seriously strained by the sub-prime mess mean that recession is a real possibility.
However, oil prices will probably stay high, unless there is a very severe recession in the US and a very serious slowdown worldwide. But that isn’t likely.
Growth in China and elsewhere will not collapse just because the U.S. enters a recession, which with any luck, it won’t. There is significant endogenous growth in China, and China has important export markets apart from the U.S. Furthermore, there are areas of high economic growth apart from China.
The whole cocktail is a potent one, and is not solely dependent on the U.S. economy for its zing.
