Last year it was tiny: about 1 per cent much as it was in the early 1970s and nothing
Posted in General on 23. Aug, 2010
Last year it was tiny: about 1 per cent, much as it was in the early 1970s and nothing like the 6 per cent it was in 1982-83.Now look at those three projections on the right hand side. If oil goes back to $28 the rise is line C; if it stays where it is now, the rise is line B; and if it goes to $45, it becomes line A. The jump in line A is similar to the jump in 1973-74 right over on the other side of the chart.Other calculations have been made about the impact of the oil price rise so far both by commercial forecasters and by official ones like the IMF. The general judgement seems to have been that what has happened so far is likely to knock around half a percentage point off global growth next year. But that is not too much of a worry if the underlying growth rate is 4 per cent or more.What that sort of calculation cannot do, though, is to capture the dynamics of a shock.
There are two important differences now from the situation in the early 1970s. One is the inflationary/deflationary balance; the other the present state of currency blocs.In the 1970s the oil price rise fed into the general inflationary situation, giving a further twist to the upward inflationary spiral. It did not cause the great global inflation, but it increased the cost of fighting that inflation Now the dynamics are different. The oil price rise is an inflationary shock hitting a deflationary world.
So it is much harder for companies to pass on the higher costs of energy by upping their prices – look at consumer resistance to higher petrol prices. In addition companies have a new technology available as a result of the communications revolution that enables them to make massive increases in efficiency. So while the rise in the oil price puts pressure on firms to crunch down all their costs, rather in the same way that any such squeeze (say from a strong exchange rate) would do, it comes at a time when they ought to be able to claw a lot of the costs back.But not all companies and not all countries are equally affected. The region most affected is East Asia because it is relatively short of oil itself and because it has been experiencing high growth rates. Nevertheless some countries in the region, such as Malaysia, are significant producers and will gain growth; others, like Taiwan and Thailand, seem particularly exposed. The region as a whole is only just recovering from regional weakness of three years ago.
The balance sheets of many companies and some banks are still weak. The danger is that there could be some sort of re-run of the domino effect of recent memory.The other dynamic that is quite different is the state of currencies. At the time of the 1973-74 oil shock the world was adjusting to floating exchange rates. following the final collapse of the Bretton Woods fixed exchange rate system in 1972. Floating rates enabled the world to accommodate the shock, albeit at the cost of inflation. It could, so to speak, roll with the punches.Now we have reinstated a fixed exchange rate system in the shape of the eurozone. True the big European oil producers, Norway and the UK, are outside the zone, but there are still differential effects Some countries are more affected than others.
Meanwhile, Europe as a whole may be more disadvantaged than North America. We simply don’t know how large the oil shock is in relation to the other difficulties of Europe, but it does, so to speak, knock the currency when it is already down. High oil prices may be particularly bad for the euro.It is these dynamics that raise the stakes. The basic calculation that the world economy ought to be OK with the oil price at $35 a barrel is still valid But there are big risks and those risks increase every day Keep fingers crossed.
More from Hamish McRae. Robert Hughes, Clive James, Kathy Lette – all Australian émigrés who have been sent back to their native coutntry to report on it.