Oil Prices And The Illusion Of New Inflation

It has become commonplace among analysts and oil traders to fear that crude prices are up so much that inflation will have to return the market. A recent piece from Reuters reinforces that sentiment.

But, inflation is based on the ability of businesses and consumers to continue to buy what they buy now and take on spending more on petrochemicals, oil, diesel, and gas.

“Oil inflation” is much more likely to drag the economy deeper into a recession than it is to drive up the costs of goods and services. Airlines, trucking firms, industries that have costs of goods based on petrochemicals all face the effect of oil prices. Almost none of them have the expanding revenues to pick up those costs and maintain their current employment levels and capital spending. The by-product of crude price increases is layoffs and cost cuts.

The consumer is in a similar bind. He does not have the discretionary income to absorb an increase in oil. Real wages are not rising. If anything, they are moving down. The consumer’s alternatives to paying more for gas and heating oil are extremely limited. Gas prices at $3 or more a gallon will put many households back to where they were a year ago–facing the choice of driving or paying down credit cards. A real spike in crude may even put the ability of many people to pay their mortgages at risk.

Oil prices may be driven higher by economic rebounds among the BRIC nations. Their low cost/high export models have been hurt by the recession, but government stimulus spending has increased the power of their consumers to spend and of their businesses to expand. Both of those things help increase crude demand. On the other hand, producing nations have been forced to cut exploration because oil prices were down for several quarters and the recession has undermined their national budgets.

Inflation is not the result of higher oil prices. Another recession maybe.

Douglas A. McIntyre