Here we go again: $100 oil

By Money Matters Editors

The U.S./global economic recoveries are underway, that we know. What economists and sector analysts don’t know is the whether this recovery has legs, i.e. whether it is sustainable.

Regarding the United States, the world’s largest economy, the upturn in U.S. manufacturing is one of four, key economic expansion/contraction indicators and the main reason most economists believe the economy is expanding.

However, the other four – sales (sluggish), incomes (stagnant), and payrolls (still declining), do not point to a recovery. If the three aforementioned don’t begin to trend higher, the sustainability of the rebound will come under serious questioning, as opposed to just muttering and ‘devil’s advocate’ critiques one hears now.

What’s another factor that could stop the recovery in its tracks? You guessed it: the price of oil. Institutional investors (IIs) have bid-up the price of oil to about $80 per barrel, partly as an asset play and partly due to fears about inflation. Oil is serving as a ‘temporary surrogate currency’ or ‘surrogate gold’ right now. But oil also is rising due to projected increasing demand in emerging markets – where the economic recovery appears to be on sounder footing. Given the latter, OPEC needs to increase production at its next meeting: if it doesn’t, $100 per barrel oil seems to be a certainty in 2010, and that would be counter-productive.

Counter-productive, because, although sky-high oil prices lead to net economic gains for oil producer states and oil companies, the impact is net negative just about every where else, from corporate revenue and GDP standpoints.

And the U.S. economy would be hit especially hard. Here’s the economic reality: every $1 per barrel rise in oil decreases U.S. GDP by $100 billion per year and every 1 cent increase in U.S. gasoline prices decreases U.S. consumer disposable income by $600 million per year.

Moreover, $100 oil prices, and the accompany $3 per gallon gasoline, would serve as a headwind on sales, incomes, and payrolls just as it appears the U.S. economy is starting to gain momentum, and those sky-high prices could trigger a double-dip recession.

Hence, OPEC’s decision is obvious enough: increase production at its next meeting in December. And don’t cop-out by claiming that high oil prices are due solely to a weak dollar and the U.S. budget and trade deficits. They play a role, but the United States will take care of its budget deficit in due course. In addition to the aforementioned factors, high oil prices are also caused by a world thinking emerging market economic growth in Asia is going to outstrip global oil supply increases. OPEC can do a lot to quell that sentiment by increasing production. If it doesn’t, and it pushes the market to the max again regarding how high a crude price the market can tolerate, there’s a 50 percent chance that inaction will push the U.S./global economies back to where no one wants them to be: in recession.