U.S. Economic Locomotive Not Easily Derailed

The U.S. economy, we were told at the beginning of the year, is in trouble. The boom in house prices is producing a bubble that will burst, with consequences even more dire than the bursting of the Internet bubble. The dollar will fall, and the federal budget deficit rise, increasing inflationary pressures, and forcing a growth-stifling rise in interest rates. And soaring oil prices will be the final straw that breaks the back of the U.S. economy.

Instead of falling, the dollar has risen, helped along by the sag in the euro as it becomes increasingly apparent that the eurozone economic model is on a hiding to nowhere. Thanks to robust receipts, and in spite of a battle between President Bush and Congress for the prize as America's top profligate, the budget deficit has declined. Inflation has remained tame, and long-term interest rates have not responded significantly to Federal Reserve Board Alan Greenspan's efforts to force them up by raising short-term rates. The phrase "Goldilocks economy" is once again heard in the land.

Which brings us to oil. The doomsayers predicted that prices would rise, and they have been right. But only in part. True, oil has hit and pierced the $60 per barrel level. True, too, this has put a crimp in the ability of lower income folks to spend money on other things, although even that is not clear, since Wal-Mart reports June sales up 11.7% over last year.

But the resulting high petrol prices have not, at least not yet, had a major impact on the economic growth rate. That is probably due to two facts. The first is that it would take prices in the range of $3.50 per gallon to equal what drivers were paying back in 1980.

Second, General Motors, and now Ford and Chrysler, are making it cheaper than ever to own big, comfortable, safe, four-wheel drive sports utility vehicles (SUVs) -- the bane of existence of the radical-left protestors at the G8 summit, and the radical-right protestors in the U.S.

In an effort to pare inventories, GM hit upon the idea of offering all buyers the same discount as is made available to its employees. The simplicity of the offer, and the fact that it took already-discounted prices down by another 5%, led customers to storm showrooms and reduce GM inventories of unsold vehicles from about 1.2 million to 994,000. Since Ford and Chrysler also benefited from the surge of consumer interest, industry-wide stocks are now down to levels that will force the companies to step up production in the fourth quarter.

That should add to the strength the economy is already demonstrating. The Institute for Supply Management reports that the service sector, the economy's largest, grew for the 27th consecutive month in June, and the government reported late last week that the service sector added 150,000 jobs in June. JP Morgan Chase adds that overall business investment rose at an annual rate of 8% in the second quarter, double the rate in the first quarter. Total real (after-inflation) after-tax income is rising at an annual rate of around 3.5%, and consumer confidence is high and rising. No wonder, since the unemployment rate has dropped to 5.0%, and the number of workers unemployed for more than six months declined by 2.3%.

As is always the case, the economic horizon is not cloudless, especially when scanned from the vantage point of a foreign policy observer. As last week's events in London demonstrate, the risk of a terrorist attack remains; support for President Bush's Iraq policy is wavering; the gutting of the reform movement by Iran's hardliners bodes ill for stability in Iraq and the Middle East; and the Chinese regime refuses to force the North Koreans to abandon their nuclear dream.

At home, the strength of the dollar will inevitably cut into exports and encourage imports; protectionist sentiment is rising, spurred on by China's attempt to acquire Unocal; it is unclear whether the president can or cares to restrain spending; and his economic team remains closed to outside ideas. "We don't do dissent here," one White House aide told me a few weeks ago.

Whether oil should be added to this list of negatives is unclear. Saudi officials are claiming that the Organization of Petroleum Exporting Countries will be unable to meet the long-term needs of consuming countries -- at least, not at existing prices. But the Saudis are not renowned for veracity. Their claim of a potential supply shortfall is useful in keeping prices high, as the Saudis well know, and ignores any efficiency savings that the high prices will inevitably induce, as previous price run-ups have done, and the growth of non-OPEC supplies.

BP has begun to tap four giant fields off the coast of Louisiana and expects production to hit 500,000 barrels per day by around 2008. Exxon Mobil expects some 27 of its new projects to flow some 1.2 million barrels per day onto world markets at about the same time. Caspian supplies have begun to hit the market, and the supply of oil being squeezed out of Canada's oil sands is rising.

All in all, Cambridge Energy Research Associates (CERA), a well-regarded American consultancy, expects so many new fields to come on line in the next several years in response to stepped-up exploration that supply will exceed demand -- another way of saying that it expects prices to fall.

Until we can get a better view of the extent to which $60 oil will reduce demand by inducing a new wave of conservation, and increase supply by making exploration more attractive, we can't do more than guess whether $100 oil or $60 oil, or even $30 oil is in our future. But we can guess that the current price, although not without effect, cannot alone derail the U.S. economic locomotive.

A version of this article appeared in The Sunday Times (London).