500 per cent increase in oil prices may be the key driver behind global recession: CIBC World Markets report
Americans' cost of importing oil up US$200 billion a year TORONTO, Nov. 3 /CNW/ - CIBC (CM: TSX; NYSE) - The staggering rise in oil prices since 2002 may be playing a far more significant role in pushing the global economy into a recession than the sub-prime mortgage meltdown in the U.S., finds a new report from CIBC World Markets. The report, titled "Just how big is Cleveland?", challenges how falling property values in U.S. inner-cities like Cleveland could create a recession in Japan and the Euroland economies, before even causing a recession in the U.S. economy. "Four of the last five global recessions were caused by huge spikes in oil prices. And the world economy is coming off the mother of all spikes," says Jeff Rubin, chief economist at CIBC World Markets. "Over this cycle, real oil prices have risen over 500 per cent, twice the rise in real oil prices that produced the two biggest recessions in the post-war era: the 1974 recession and the double-dip recession in 1980 and 1982. "If oil shocks half the size of the recent one caused the worst recessions in the last fifty years, they're a pretty obvious explanation for the recessions in oil-dependent Japan and Euroland earlier in the year. And even back in Cleveland, few could doubt the link between $4/gallon gasoline last Memorial Day weekend and what's happening in Detroit today. And from where the U.S. economy currently stands, vehicle sales have a much bigger downside than housing starts." The report notes that in the past, oil shocks have triggered global recessions by transferring billions (or now trillions) of dollars of income from OECD economies with typically very low savings rates to OPEC economies with typically very high savings rates. For example, the transfer of income from U.S. consumers to Saudi producers involves moving money from basically a zero-savings-rate economy to one in which the saving rate is around 50 per cent. "While many of those petro-dollars get recycled back into the financial assets of OECD countries, many of them never get spent," adds Mr. Rubin. "Hence, the redistribution of global income from oil-consuming countries to oil-producing countries is far from demand-neutral insofar as the global economy is concerned. "Those same transfers are occurring now, and at recent triple-digit oil prices, they are occurring on an even more colossal scale than ever before. The annual U.S. oil import bill has risen by a staggering $200 billion since 2005. That's bigger than Congress' entire fiscal stimulus package." This scenario has been true for the incomes of all OECD countries. Over the last five years the fuel bill has grown a staggering $700 billion annually, with $400 billion of this going to OPEC producers. In effect, these massive cash transfers mean that more and more of the world's income gets saved and less and less spent. That demand leakage shows up in a weaker world economy. The report notes that both the Japanese and European economies are far more vulnerable to oil price spikes than the American economy. While the U.S. economy consumes 19 million barrels per day, 5 million of those are produced domestically - and that part of the American economy gets a boost from soaring oil prices. Japan, on the other hand, must import nearly all of its oil. With the exception of Russia and a few North Sea states, Europe is essentially the same. As a result, these economies are almost twice as sensitive to an oil shock as the American economy. But the American economy is also vulnerable. "The one-two punch from record fuel bills and end of the tax rebates saw consumer spending plunge at a 3.1 per cent rate in the third quarter, the largest decline in over a quarter century," says Mr. Rubin. "Significantly, the last drop in household spending occurred in a previous energy shock, caused by the 1990 Iraq war. "Plunging motor vehicle sales accounted for the largest single component of the drop in Q3 spending. And the risk is that the damage there is far from done. The past year's high pump prices have not only decimated sales but sparked a discernable, potentially lasting reduction in miles driven. Nor is the damage from high oil prices limited to automobiles. Four-fifths of GDP shows a strong negative relationship to high energy costs. That includes the negative effect on a wide range of industries, including travel and agriculture, which increasingly just turns petroleum into food." The report also notes that research has found that that it takes about a year for an oil price shock to have its maximum impact on U.S. GDP. Energy economist James Hamilton reported these lags fit the experience of past shocks, including the OPEC-induced recessions of the 1970s. Among other factors, the unwinding of an involuntary buildup of autos and other durables is a key determinant of the lag structure involved. It has also been found that a similar lag structure holds for the impact of large declines in oil prices. The virtual collapse in oil prices to US$12 a barrel in 1986 was a key driver behind a rebound in U.S. economic growth to a four per cent-plus pace, even in the face of mounting financial costs from the savings and loan crisis. "Given that oil prices really took off in the third quarter of last year, after several years of more gradual increases, we should expect to see its maximum hit on the economy right about now," adds Mr. Rubin. "By the same token, however, the impact from the even larger decline in oil prices over the last two quarters should give its maximum boost to the economy over the next six months. "If triple-digit oil prices are what started the recession, then $60 oil prices are what will end it." The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/soct08.pdf. CIBC World Markets is the wholesale and corporate banking arm of CIBC, providing a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. We provide innovative capital solutions and advisory expertise across a wide range of industries as well as top-ranked research for our corporate, government and institutional clients.