Threat to Oil Conjures Up Specter of ‘70s Stagflation
Iraq’s seizure of Kuwait’s oil facilities has revived an economic specter that vanished with the gas lines of the 1970s: stagflation, a U.S. economy squeezed between rising consumer prices and sinking business activity.
As was the case with the 1973-74 Middle East oil crisis, oil prices now threaten to push up inflation at a time of growing unemployment and economic sluggishness. Indeed, the word stagflation--forgotten during the boom years of the 1980s--is creeping back into the economic vocabulary.
“There’s no question that stagflation is back,” said Irwin L. Kellner, chief economist at Manufacturers Hanover Bank in New York.
Donald Ratajczak, director of Georgia State University’s economic forecasting center, agreed. Stagflation, he said, “is as good as any word you could use for this period.”
The Middle East conflict adds a note of confusion to a period in which the U.S. economy tilts precariously close to a recession.
In the latest indicator of the economy’s weakness, the Labor Department reported Friday that unemployment rose to 5.5% in July from 5.2% in June, the highest level in two years. The economy’s rickety shape already had been underscored by gauges of consumer spending, construction and factory orders in recent months.
A sharp boost in oil prices--by drawing away consumer spending and raising the cost of business--could throw the economy into a recession, analysts said. “With the economy already sluggish, that could be enough to make the difference” and spur a full-blown recession, Ratajczak said.
Rising oil prices and a sluggish economy also pose a dilemma for policy-makers: If they cut interest rates to stimulate the economy, they could aggravate inflation even more. But failing to act could lead to a recession. In effect, stagflation is the worst of both worlds; normally, when economic growth slows, inflation is not a major threat.
At the same time, analysts are quick to point out important differences between today and the 1970s, differences that make acute stagflation--featuring rampant price hikes--unlikely.
The U.S. economic machine is less dependent on oil than it used to be, and inflation remains a much weaker force than in the past. “I don’t like to use the term ‘stagflation’ because it implies permanence, that we’re stuck with inflation and slow growth,” said Mickey D. Levy, chief economist at Fidelity Bank in Philadelphia. “I don’t think we’re stuck with it.”
A rough rule of thumb holds that a $1-a-barrel hike in the price of oil translates to a onetime 0.1% rise in consumer prices. Futures prices for West Texas Intermediate crude oil--the benchmark U.S. grade--have shot up $10 a barrel since June, about half of that in this week alone. Thus some experts expect the higher oil prices to add as much as 1 percentage point to the consumer price index, which shows inflation now rising at about a 5% annual rate.
Compared to the past, such a rise may seem tame. Still, since the invasion by Iraq, investors have behaved as if the clock were turned back to 1973-74--the period of the first oil shock. On Thursday and Friday, nerve-wracked investors sent stocks and bonds plummeting.
“Look at what’s going on in the markets right now--they’re saying: ‘What happened in 1973?’ Let’s act accordingly,” observed Ratajczak.
Since 1973, however, the world--and U.S. industry--have changed. That year, oil represented 46.9% of total U.S. energy usage, according to the Department of Energy. By last year, oil’s role had slipped to 42.1%. It now takes 28% less energy to produce $1 worth of goods than it did in 1973, according to Ronald J. Planting, a senior analyst with the American Petroleum Institute in Washington.
Moreover, today’s economic climate is less friendly to inflation than was the case two decades ago. Wage settlements often fail to keep up with price rises these days, according to economists--in marked contrast to an earlier era when wages and prices seemed to soar in an endless spiral.
The U.S. economy is so listless that even higher prices for gasoline and heating oil are not expected to set off anything like the double-digit price hikes of the past. Large regions, including New England and New York, are already suffering recessions. California and the West have more buoyant economies, but cutbacks in defense and a poor housing market are taking a toll on growth.
Because of the varied weaknesses, higher oil prices “are not going to bring inflation roaring back,” maintains Christopher N. Caton, director of forecasting at DRI-McGraw Hill in Lexington, Mass.
But some of those concerned about stagflation see the potential for inflation in a very different light.
Kellner, for example, points out that inflation in various services has risen substantially over the last year. In the last 12 months, costs for medical care and public transportation have risen 9.2%. Tuition and other school fees are up 8.1%, he said, in contrast to a 3.8% inflation rate for goods during the same period.
Others wonder if the inflationary effect of a flurry of statewide tax increases has been fully recognized. At least a dozen states have raised taxes or fees for the 1991 fiscal year to get needed income, according to the National Assn. of State Budget Officers in Washington. California, for example, just implemented a new 5-cents-a-gallon tax on gasoline.
And “a nickel more a gallon is a price increase,” said Robert T. Falconer, an economist at Aubrey G. Lanston & Co., a securities firm in New York.
Clearly, a U.S. economy that simultaneously is threatened by inflation and slow growth becomes a more troublesome creature for U.S. policy-makers than the more simple, sluggish version before the Iraqi invasion.
Earlier this week, when inflation seemed less of a problem, many analysts expected the Federal Reserve Board to lower interest rates to stimulate the economy. Now--even though the economy remains dangerously sluggish--the new wild card of oil-driven price rises makes lower interest rates a far trickier matter.
If the Fed pushes interest rates up to fight inflation, “it will create recession,” warns Ratajczak. “If the Fed fights recession, it certifies inflation--it makes it happen.”
In any case, Fed officials may have some time to ponder the altered state of affairs. “Oil prices are going to be under pressure for quite some time,” said economist Falconer.
The nation’s unemployment rate rose to 5.5% in July. D1
