Thursday, June 15, 2017

How This Economic Recovery Ends

Every time there's full employment, there's a spike in oil prices. And guess what comes next.


By Conor Sen
The Bloomberg View
June 15, 2017

Every boom in the U.S. economy is different, but over the past several decades, each has ended the same way. First you get full employment. Then you get a spike in the price of oil. And then there's a recession.

The U.S. hit full employment in August 2015. And yet the prevailing wisdom is that oil prices will hold steady around $50 per barrel, or even fall because of production gluts. What could cause a spike? It's worth looking at both history and current events.

The unemployment rate has gotten to 5 percent or lower four times since the early 1970s, and each time the economy followed this pattern with an oil spike and a recession. The first and most extreme case was the 1973 OPEC oil embargo that began in October 1973. At that time the unemployment rate was 4.6 percent. Over the next five months the price of oil tripled in global markets, plunging the U.S. into an immediate recession that eventually coincided with the resignation of President Richard Nixon.

The second case was the First Gulf War. The unemployment rate touched as low at 5 percent in early 1989. Because of rising tensions in the Middle East, eventually leading into Iraq's invasion of Kuwait and the American military response, the price of oil jumped from around $16 in June 1990 to $40 later that fall. Recession began in July.

The late 1990s boom in the U.S. may be remembered more for technology stocks, but it also coincided with an oil spike. After the emerging market crises of 1998, the price of oil dropped as low as $11 a barrel. Yet by March 2000, as technology stocks were peaking, it had soared to over $33 a barrel, its highest level since the Gulf War. And in the last economic cycle, even as the housing market was collapsing, the price of oil soared, rising from $52 a barrel in January 2007 to almost $150 a barrel by the summer of 2008.

Global markets were obsessed with oil from 2014 through 2016 and the risks that its drop posed to markets and economies. Yet for consumption-led economies like the U.S., it's a rise, not a fall, in the price of oil that is worrisome. And the time to worry about a spike in the price of oil is when the labor market is around full employment. In all four of the cycles described, that spike -- at least a doubling in all four occasions -- never took more than a few years after the unemployment rate hit 5 percent.

With supply-and-demand fundamentals seemingly so poor for oil at the moment, what could possibly lead to a spike in oil by the end of the decade? First, as news out of Qatar this month reminds us, geopolitics can emerge as a risk at any time. Second, in the wake of the oil price drop over the past few years, investments in energy exploration and production fell sharply. Exxon's capital expenditures in the first quarter of 2017 were at their lowest level since the first quarter of 2005, and that's in nominal dollars. In real dollars you'd have to go back further than that. Less investment now will eventually mean lower production in the future and tighter supply.

And third, full employment has its own dynamics. It means energy firms looking to staff up are potentially competing with other sectors like construction for workers and raw materials, raising production costs that then have to be passed on in the price of oil. While the U.S. economy is less energy-intensive than it has been in the past, companies looking to become more efficient on the labor front may employ energy-intensive equipment or machinery.

Finally, one can't help but notice that oil spikes and the following recessions were followed by the departures of three of the last four elected Republican presidents -- Nixon and both Bushes. If an unpopular health-care bill and the Russia investigation don't take down the Trump presidency, perhaps $100 oil will.


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