The Mideast Crisis Won’t Mean Economic Disaster
The swirling sands of the Mideast crisis may make it more difficult to see the road ahead, but this does not mean that planning should cease. Data on the state of the economy, government policy and technology suggest the following:
* No long lines at the gasoline pumps.
* No double-digit inflation.
* A recession that might be milder than otherwise.
* Interest rates remaining high.
Let’s take these one at a time.
We’re not likely to face long lines to fill up our cars for one simple reason--the government is out of the picture. There are no longer any federal controls on oil and gasoline prices, nor is Washington telling the oil companies where to ship their products.
This is not trivial. In the 1970s, controls distorted supply and demand. By keeping prices down, they encouraged demand (including panic buying) and discouraged supplies.
As long as the price mechanism is allowed to work, supply and demand will find a balance and lines will not develop. To be sure, prices will rise. However, this will cut demand (by encouraging conservation) while increasing supply.
As for prices, they’re not likely to jump as much as they did in the 1970s, thus avoiding another round of double-digit inflation.
First of all, oil prices this year have gone up only about 70% from last year’s levels. In 1973-74 they jumped fivefold, while they more than doubled in 1979-80.
Second, money is tighter today than it was in the 1970s, and inflation-adjusted interest rates are much higher. This means that there simply isn’t enough liquidity in the system to support a generalized round of price hikes; some prices will have to be cut to make way for more costly oil.
Indeed, that is already happening. Detroit is cutting prices on some models; clothing stores are cutting prices on apparel; hardware stores, consumer electronics retailers and restaurants are offering lower prices.
Tight money has also produced less inflation today than in the 1970s. This kind of environment, reflecting tougher stands against price increases, makes it even more unlikely that double-digit inflation will develop.
Adjusted for inflation, the retail price of oil and gasoline is far below the early 1970s, and remains so even after recent price increases. This means a proportionately smaller impact on people’s wallets from this year’s run-up.
Then there’s energy efficiency. It now takes 40% less oil to produce each $1 of real gross national product than it did in 1973.
Transportation, the biggest user of oil, has become significantly more efficient. The average car on the road today gets 21 miles per gallon--a 60% improvement from 1973.
Electric utilities, which require a growing share of the energy used in this country, now derive less than 6% of it from oil, compared to nearly three times as much in 1979.
We’re unlikely to catch the inflation virus from abroad, either. Other Western countries are even more energy efficient than we are--and their currencies have risen against the dollar so they won’t have to pay much more for oil, because it is sold for dollars.
Back home, the U.S. economy has slowed to the point of recession. Revised data from the government confirms that, after adjusting for inflation, actual sales to final consumers declined in the second quarter of this year--the first quarterly decline since the last recession.
Under these circumstances, an increase in the price of such an important--and ubiquitous--commodity as oil is not inflationary, but deflationary. Since both labor and business are too weak to boost wages and prices to compensate, higher oil and gasoline prices will simply drain buying power meant for other goods and services.
Don’t be surprised if sales of all but the strictest necessities fall. This will put a squeeze on business profits, which have already declined for nearly two years.
The drop in sales and employment will reduce tax revenue flowing into Washington. At the same time, the added expense of our military involvement in the Middle East will boost federal spending. The net result: a budget deficit that will break all records.
Deficits must be financed, and government borrowing to fund this one is bound to keep interest rates high. The Federal Reserve should respond by easing money at least a touch, as I argued in my last column, but I’m afraid it won’t until it perceives that recession is the greater threat than inflation. By then, of course, it will be too late.
Be that as it may, this recession may not be as bad as anticipated. The military action alone means that defense spending will not be cut as much as planned. This suggests more business--and more jobs--for many government contractors, including quite a few in Southern California.
Speaking of jobs, the call-up of reserves will create some openings, however temporary, and is bound to cut the jobless rolls too.
Then there’s the impact of the increased price of petroleum. When oil was priced around the $15-per-barrel range, the industry found it uneconomical to drill for more. Now that it has reached the $30-per-barrel range, it becomes much more worthwhile to look for oil. Among the regions, expect the Southwest’s economy, already on the mend, to pick up smartly. Steel, real estate and financial institutions should do better too.
The economy has always snapped out of any recession once a war got under way. So if the current military action turns into a full-scale war, the same might be expected this time. As for stocks, a look at the record shows that the market has gone up during each of this century’s four major wars, so recent declines might represent a good buying opportunity.
