GREENSPAN: OIL, THE FINAL HURDLE

One month of good job numbers, one month of slight price increases and one quarter of strong growth, while promising, do not an economic recovery make. While the markets may be anticipating a rate hike to stave off a resurgent economy (quick, before we create any more jobs and spark inflation!), looking deeper at the CPI shows that price increases are not coming from wagepush inflation (what with some 8 million people out of work), but from skyrocketing energy prices (we knew it was a war for oil, but we didn't know it was a war to drive up oil prices).

At a seasonally adjusted annual rate, energy prices grew 38.6% in 2004 Q1; petroleum-based energy prices rose 82.5%. In sum, the increase in energy prices accounted for half of the overall increase in the CPI. Also a big price mover was transportation (last I checked, transportation was heavily dependent on petroleum fuels), which grew 15% in the first quarter.



Speaking at CSIS yesterday, the Maestro warned of the threat that oil and other energy prices pose to the US (and the world) economy:

The dramatic rise in six-year forward futures prices for crude oil and natural gas over the past few years has received relatively little attention for an economic event that can significantly affect the long-term path of the U.S. economy. Six years is a period long enough to seek, discover, drill, and lift oil and gas, and hence futures prices at that horizon can be viewed as effective long-term supply prices.

These elevated long-term prices, if sustained, could alter the magnitude of and manner in which the United States consumes energy. Until recently, long-term expectations of oil and gas prices appeared benign. When choosing capital projects, businesses could mostly look through short-run fluctuations in prices to moderate prices over the longer haul. The recent shift in expectations, however, has been substantial enough and persistent enough to influence business investment decisions.

The rise in prices, coupled with the miasma in Iraq, questionable relations with Saudi Arabia, fraudulent reserve estimates from some global oil producers, and ongoing violence and opposition to the United States in much of the oil producing world combine to create conditions of uncertainty that are anathema to financial markets. This market uncertainty, and the US economy's perennial oil dependence, blurs the economic outlook and jeopardizes the budding but not yet crystalized economic recovery.

C'est la guerre.