Friday, February 25, 2011

Inflection point number 2: Gas prices

- by New Deal democrat

As I noted last week, two indicators - initial jobless claims and the price of Oil - were nearing inflection points. Yesterday the 4 week average of jobless claims came within a whisker of crossing the 400,000 threshold consistent with a self sustaining recovery that adds more jobs than it needs to accomodate population growth.

This week the price of Oil actually did cross the threshold of 4% of GDP (about $94 a barrel based on the latest data) historically associated with economic slowdowns and recessions. As I indicated last week, I'm a little less sanguine about this than my co-blogger Bonddad, whose latest post is just below, here.

Professor James Hamilton has done some excellent work on oil-induced recessions, but all of those involved (1) a sudden spike in Oil prices that (2) with one exception went substantially above the 4% of GDP threshold. What his data doesns't have much to say about is the few cases where Oil has gradually approached or brushed the 4% threshold. In the 1990 recession, there was a spike that just passed the 4% threshold. The only other occasions are 2005-2007, last spring, and now.

Since the St. Louis Fred only tracks Oil prices monthly, in the graphs below I have made use of their weekly gasoline price data (blue) compared with the S&P 500 index (red). First, here is a look at the last 10 years:

Note first of all tht in general gas prices track economic growth. As there is more growth, there is more demand, and prices go up -- up to a point. Secondly, note that in 2005 (Katrina) and 2006, when gasoline crossed $3/gallon, the S&P 500 backed off. Indeed in 2006 GDP slowed down for one quarter to a just barely positive crawl. Both of these spikes to ~4% of GDP were short-lived. When in 2007 prices decisively moved through the barrier, the S&P anticipated that move by a couple of months. Finally, last spring when Oil brushed $90 a barrel (4% of GDP then), the S&P backed off 15%, and GDP immediately slowed to 1.7%. In all of these cases, of course, Oil was not the exclusive culprit, but the pattern remains.

Now here is a close up of the last 12 months:

The 15% downward move in the S&P last spring described above shows up more clearly here. While again generally energy prices are highly positively correlated with economic growth, note that this week as gas prices moved decisively above $3 a gallon, and Oil shot up from ~$90 a barrel to briefly over $100 a barrel, the stock market moved inversely to those prices, showing that the inflection point has been reached.

While as I say I am less sanguine than Bonddad, our points of view (and that of Prof. Hamilton) are not that different. Prof. Hamilton expects a few tenths of percent of GDP to be shaved off by prices as of a few days ago. I am expecting a slowdown similar to spring of last year - and I believe that is already showing up in real retail sales, for example.

So long as Oil supply from the Mideast is not disrupted, that is all I am expecting. Specifically, I do not foresee a "double dip." If on the other hand, disruptions in supply or speculation do cause Oil prices to continue to climb another $20 a barrel (or about $.50 a gallon of gas) as they have in the last 5 months, there will be further damage and I am sure Prof. Hamilton will agree with that.

In the Bigger Picture, it would be nice if Versaille could look beyond trying to apply the Shock Doctrine to seniors and the states, and actually take action that would begin to immediately loosen the choke collar that is Oil around the neck of the economy.