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The Oil Effect

Irwin M. Stelzer

We should “stop thinking about the economy as being in a perpetual crisis” commented Charles Plosser, President of the Federal Reserve Bank of Philadelphia, after the government announced on Friday that the private sector added 267,000 jobs in January, and that upward revisions to November and December data brought total job creation in 2014 to over three million. Wages are moving up faster than inflation, prompting some observers to back off predictions that Fed chair Janet Yellen would delay raising interest rates beyond June. I am not so sure. Janet Yellen just might argue that the increase in pay was due to the decision of many states to raise their minimum wages rather than to an overly tightening labor market, and that 703,000 workers re-entered the work force, suggesting that the reserve army of the unemployed is too large, and at least large enough to provide workers to meet demands without triggering inflation-inducing wage increases.

So far, the uplift lower gasoline prices is providing to other sectors — most especially autos and retailing — seems to be more than offsetting job losses in the oil and related industries. That is not to minimize the devastating effect of the 60% drop in oil prices. In North Dakota, the second largest oil-producing state after Texas and the heart of fracking country, almost 25% of the drilling rigs in operation at this time last year are now idle, and the total number of rigs working in America is at its lowest level in three years. Layoffs are not confined to smaller, debt-laden fracking operations. ConocoPhillips, BP and Shell have warned their employees to expect staff reductions, while industry suppliers from Schlumberger and Halliburton to small shops that supply beer and sandwiches to oil-field roustabouts and posh restaurants in Houston that cater to oil industry executives are paring staffs. One such eatery is tying the prices on its upscale menu to the daily price of oil.

But it is the net effect of this precipitous change in the oil business that matters. The (far from infallible) forecasters at the International Monetary Fund expect lower oil prices to add a full percentage point to the growth rate of most advanced economies. American consumers have so far saved rather than spent their bonanzas, shoring up their balance sheets by adding some $75 billion to their rainy day accounts and increasing their confidence in their economic futures. Motorists can expect to pay an average of $2.33 per gallon to fill their tanks this year, about $1 per gallon and $750 per household less than in 2014. Throw in an additional $750 for those who heat their homes with oil, and the savings move from non-trivial to significant, adding still more to consumer confidence and spending power.

The biggest winner so far is the auto industry. Low gasoline prices, an improving economy, available credit, and good weather propelled sales of cars and light trucks up by 14% last month, to the highest annual rate since 2006. More important to the car makers’ bottom lines, sales of pickup trucks and sport utility vehicles rose 19.3% in January, compared with a 7% increase in comparatively gasoline-sipping passenger car sales. Sales of these high-margin vehicles raised average sales prices of GM vehicles by $2,400, drove capacity-utilization rates to record levels, and prompted manufacturers to add staff to meet demand.

Now it’s the housing industry’s turn to add to the boost created by the auto industry. Whether it will do so is uncertain. The housing market seems set for a good year at the top end, reflecting the distribution of gains from the ongoing recovery, a distribution that favors high-earners. Toll Brothers, which builds homes with an average price well above $700,000, reports fourth quarter profits up almost 40%. Other large publicly traded builders that specialize in more expensive homes are reporting significant gains in sales contracts signed in their most recent quarters compared with a year ago. At the starter end of the market the story is more mixed. On the plus side, household formation reversed its decline and increased more or less steadily last year. But many young couples are unable to qualify for mortgages from banks, wary after having been heavily penalized for making improvident loans. They are choosing between a couch in their parents’ homes, and renting apartments. It is difficult to predict whether government plans to ease equity payments required of first-time buyers will spur demand from first-time buyers, or lay the basis for another wave of home sales to buyers who eventually find themselves unable to afford the monthly payments.

But it is possible to predict that our economy will receive little help from the rest of the world. Fourth quarter growth was dragged down by something like a full percentage point, to a disappointing 2.6% (subject to a revision, likely to be downward), as the year-long gap between U.S.-made exports and our purchases of foreign-made goods soared to the largest level since 2008, despite a sharp decline in imports of oil. Two causes: the stronger dollar is making our goods more expensive overseas, and the economies of our trading partners are slowing or stalled.

Growth in China is slowing, Japan remains mired in something between no- and slow-growth, the Canadian economy is hard-hit by the decline in oil prices, and France seems to lack the political will to reform its labor market, or its agricultural policy, or its entitlement programs or just about everything else. In the good old days it would devalue the franc by a lot more than the 8% by which the euro has fallen in recent months. More important, the eurozone has yet to demonstrate how it will respond to the money-printing stimulus European Central Bank chief Mario Draghi is instituting over German objections. It is not certain that quantitative easing will offset the negative effects of Greece’s effort to get out from under the German-imposed austerity boot, and the uncertainty produced by the rise of both left- and right-wing anti-EU parties. Little surprise that the International Monetary Fund expects the U.S. economy to grow at three times the rate of euroland this year – an underestimate of the difference in my view.

Treasury secretary Jack Lew is warning that, “the rest of the world cannot depend on the United States to be the sole engine of growth…” Unfortunately, our trading partners are attempting to accelerate their growth by devaluing their currencies relative to the already strong dollar, rather than reforming their moribund economies. That will drive up the gap between U.S. imports and our exports, increasing the trade deficit and slowing growth here. That would leave Lew on the front line of a currency war, hearing cries of “You Americans started it with all those QEs.”

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