Drop in Dollar, Oil Prices Are Not Enough to Fuel New Boom
Alot of hope has been pinned on the recent declines in oil prices, interest rates and the dollar to revive a sluggish U.S. economy. Crude oil prices have recovered from their lows of early April, but they’re still about 45% below last November’s peak.
Long-term interest rates are down more than 2 percentage points from six months ago. And the dollar has dropped nearly 20%, on average, against the Japanese yen and several of the key European currencies since late September.
These declines already have sparked a boom in housing and have contributed to good-size gains in consumer spending this year.
The question now is whether they’ll be enough to generate a strong economic rebound during the latter part of this year.
California stands to benefit more than many other parts of the country from lower interest rates, cheaper oil prices and the weaker dollar. Per-capita oil consumption in the state is more than 8% higher than the national average, so the recent plunge in oil prices should provide greater savings for the area’s economy.
With home prices about 55% to 60% higher than the national average, each drop in mortgage rates results in a larger dollar decline in monthly home payments as well.
Furthermore, the dollar’s depreciation will have a double-barreled effect on the state’s economy. In addition to improving the competitiveness of manufacturing and California’s important agricultural sector, the cheaper dollar will give the key tourist industry an important lift. Nevertheless, the boost from lower oil prices and a weaker dollar nationwide is likely to be surprisingly modest. The oil “tax cut"--the change in the nation’s oil import bill resulting from lower prices--will amount to less than 0.5% of U.S. gross national product, assuming crude oil costs hold at their current level.
By contrast, the oil “tax” was more than four times that size after the price run-up in 1979-80 and 2 1/2 times that amount after the first price jump in 1973-74.
Even this year’s savings will diminish over time as lower oil prices continue to boost demand, cut domestic output and increase our dependence on imports. Moreover, there’s no guarantee that oil prices won’t move higher as refiners rebuild depleted inventories.
For consumers, the initial savings from lower gasoline and fuel oil prices will amount to an estimated $300 to $325 per household in 1986. Measured in constant 1985 dollars, higher prices squeezed household budgets by about $465 in 1973-74 and by more than $1,000 after the 1979-80 price increases.
And the series of tax cuts in 1981-83 added nearly $1,000 (again, in 1985 dollars) by the time they became fully effective in 1984.
Conservation Cut Costs
This year’s oil tax cut is as modest as it is principally because conservation efforts have reduced household spending on gasoline and fuel oil by nearly 30% in the last 12 years. Even those savings are likely to be eroded this year as lower prices encourage further increases in driving and gasoline demand.
Most of what’s left will be channeled into a variety of such small-ticket items as apparel, other soft goods and entertainment. Even that spending will be squeezed if, as expected, gains in purchasing power diminish once energy prices stabilize and inflation moves back to its underlying rate of 4% to 4.5%.
Meanwhile, the economy will be hurt by the slump in the U.S. oil industry and its impact on the energy-based economies in the Southwest and Alaska (not to mention Kern County, where nearly 60% of California’s oil is produced).
There also may be less to the dollar’s decline than meets the eye. For one thing, the dollar hasn’t depreciated much against the currencies of such key trading partners as South Korea, Taiwan, Singapore, Hong Kong and Canada--our most important trading partner along with Japan.
These countries can be expected to fill at least some of the vacuum in foreign competition created by any withdrawal of Japanese and European firms from the U.S. market. Furthermore, some U.S. firms are taking the opportunity to raise prices here, offsetting at least some of the benefits of a cheaper dollar.
In the export market, any boost from improved U.S. competitiveness will be tempered by the presence of trade barriers in some areas and weak market conditions in Latin America and the Middle East. The trade deficit will improve this year, but foreign trade will remain a trouble spot for the economy and a flash point for protectionist legislation.
Lower mortgage rates are providing a powerful lift to single-family home construction. The drop in borrowing costs during the first quarter increased by more than 525,000 the number of households qualifying for the median-priced home in California, assuming a payment-to-income cap of 28%. That’s equivalent to last year’s existing home sales and new single-family home construction combined.
But several factors are likely to throttle back housing demand here and in other parts of the country after the initial burst of activity.
First, tighter lending standards imposed last year by the Federal National Mortgage Assn.--the largest investor in home mortgages--will exclude a number of families from the market who might otherwise qualify for a home loan.
To qualify for sale to Fannie Mae, mortgages with a down payment of less than 10% now require a ratio of home payments to gross income of no more than 25%, compared to 28% previously. For home loans with less than 10% down, this change will exclude as many households from the market as an increase of more than 1.5 percentage points in mortgage rates.
Second, California home prices have been rising at a double-digit pace recently, partially offsetting the benefits of lower mortgage rates.
And third, there’s no guarantee that mortgage rates will stay where they are. In fact, rates have been drifting higher since April.
An aging business expansion could make it even more difficult for recent changes in interest rates, oil prices and the dollar to spark strong growth later this year.
True, household wealth has received an enormous boost from the rally in the stock and bond markets. However, debt burdens are at a historically high 19% of after-tax income despite the recent slowing of consumer credit growth.
Furthermore, pent-up demand for big-ticket goods has been dissipated by strong spending growth in recent years.
Last year alone, holdings of autos and other consumer durables per household--a barometer of pent-up demand--rose by more than 4.5%, compared to a long-term annual average growth of less than 3%. At the same time, excess manufacturing capacity and the slump in oil-related investment is hurting plant and equipment spending.
A cheaper dollar, along with the lower cost of fuel and financing, will keep the economy growing at a moderate pace through the end of the year. That’s no mean feat in the fourth year of a business expansion.
But don’t look for any miracles. It may be too much to expect these declines--as significant as they are--to spark a renewed boom in the economy.