Gas Prices Sudden Step Into The Limelight

It may only be dawning on the media and economists that high oil prices have pushed gasoline over $3.00 per gallon in some states. A prolonged period of high fuel prices will deaden whatever recovery the economy might be mustering.

There are several theories regarding how much high oil prices have an impact on GPD.  Certainly, if oil moves back above $100 for any extended period of time, consumer and business spending will be so badly crippled that a rise in GDP in the fourth quarter will be undermined.

High fuel prices not only rob money from the pockets of people already worried about their jobs and businesses concerned about their margins; they fog the lens that shows a better economic future in 2010. It is hard for confidence in the economy to recover when the decision between driving and eating comes back to where it was a year ago.

The improvement in corporate earnings that is now being anticipated for the second half of this year has some basis in an overall improvement in margins in many industries that are forecasting rising sales and low costs of goods. Many of those costly goods are petroleum-based or are tied to commodities that tend to rise and fall in lockstep with oil prices. Some sectors of the economy have already begun to surrender their plans for a better year than last. The airline industry recently admitted that its losses may be $9 billion worldwide this year. Fuel costs are a major cause of that catastrophe.

Unlike the solutions that the federal government has adroitly used to save banks and car companies, the energy sector cannot be restructured unless it is over a period of decades. The only portion of gas prices that the government controls is the federal tax. The Administration may decide that it is willing to give that up, but in turn it will face an additional shortfall in the revenue that is meant to partially offset spending plans and keep the deficit within the range of budget office forecasts.

There may be no exact calculation that links oil prices and GDP, but that does not mean that the connection does not exist or that the connection cannot be unusually strong and insidious. There other link that is critical to the recovery is the interplay between employment and fuel prices. It also may not be measurable with precision, but the tie is, nevertheless, extremely powerful.

Thwarting the effect of high oil prices can probably only be done by mainlining cash directly into the bank accounts of consumers and businesses. It would require a sort of tax rebate based on fuel consumption, an underwriting of transportation and manufacturing costs. A fuel subsidy might keep the economy from stalling again, but it could raise the deficit by several hundreds billions of dollars in just a year.

There is irony in the fact that the federal government believed that it could fix the financial and manufacturing bases of the economy because oil prices were so low that they could sit off to the side of the restructuring process as a quiet and reliable positive force. Instead, even the slightest rumor of an economic recovery both in the West and in China has bestirred the speculators on the floors of commodities exchanges and at electronic trading terminals.

The government may have successfully begun the process of repairing the deep erosion of the financial system. It may even be able to rebuild an auto industry that can survive in America, although it will be much more modest business than it was in the past. The Administration may be successful in adding or saving 600,000 jobs in the next 100 days. Each of these pieces is progress and gets credit as such.

Unfortunately, almost nothing overcomes rapid inflation in the prices of critical commodities. The rising costs eat away at whatever progress the economy is making and put the government into a position where it has to face another trade-off of deficit versus recovery.

Douglas A. McIntyre