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NOVEMBER 19, 2007
Is $100 Oil As Lethal As It Looks? Not by itself. But combined with the housing bust, maybe so At around $96 a barrel, oil is on the verge of smashing through two psychological barriers: the first-ever triple-digit price and the highest price ever in inflation-adjusted terms. (The previous inflation-adjusted high, in 1980, was right around $100 in today's dollars, depending on who's calculating.) So far, soaring prices have done little damage to U.S. economic growth. The big question is whether the good luck will hold—and consumer spending is the key. Higher prices at the pump rob consumers of money they would ordinarily spend on restaurant meals and flat-screen TVs. To date, though, Americans have continued to shop. Even after adjusting for inflation in the price of gasoline and other items, personal consumption expenditures have kept marching upward, rising 0.3% in July, 0.6% in August, and 0.1% in September. "There is little evidence" so far of the expected hit to inflation-adjusted consumer spending from higher pump prices, according to Action Economics, a research firm in Boulder, Colo. Economists are more worried about housing's downturn than oil's upturn, and for good reason. According to the Federal Reserve, the U.S. has roughly $20 trillion in residential real estate wealth. A 10% price decline, which many economists consider plausible, would reduce Americans' wealth by $2 trillion, traumatizing the financial system. It's not a perfect comparison, but a 50 cents increase in the price of a gallon of gasoline would cost the economy less than a tenth as much, about $75 billion a year. One reason oil prices may matter less is that the U.S. is not as dependent on oil as it was in the 1970s. According to Energy Dept. data, the amount of oil and natural gas required to produce the same amount of goods and services has declined 58% since 1973. What's more, central bankers have a better handle on inflation now than they did during the 1970s. Back then, the Fed printed money so consumers would be able to afford costlier fuel. But that caused inflation, which was snuffed out only through a long and punishing recession in 1981-82. Since then, the central bank has managed to convince the public that it has inflation under control, so even if it does loosen up the money supply a little bit more to accommodate costlier oil, doing so doesn't begin an upward spiral of inflationary expectations. In addition, drivers haven't felt the full brunt of oil's latest rise because pump prices have risen much less than the price of crude oil. Refiners have swallowed the difference in narrower profit margins. At a national average of $3.01 a gallon for regular as of Nov. 5, gasoline is still cheaper than this past Memorial Day, when it hit $3.21, even though crude prices have risen more than $20 a barrel since then. When would gasoline prices finally begin to pinch? Drivers surveyed by America's Research Group put the pain threshold around $3.50 a gallon, according to C. Britt Beemer, chairman of the Charleston (S.C.)-based con- sumer research firm. But people have said such things before, only to keep right on pumping as prices have crossed one threshold after another. Then again, this time might be different. "I think we're in totally new territory," says Todd Hale, a senior vice-president for market researcher Nielsen. Sky-high oil could prove too much to bear at a time when housing is sinking. Weeks ago, when oil rose to the mid-$80s per barrel, Standard & Poor's (MHP ) economists estimated that if prices stayed at that level through 2008, oil and the housing slump combined could squeeze growth next year to as low as 1.5%, vs. 3.9% in this year's third quarter. A price of close to $100 would obviously hurt even more.  By Peter Coy, with Nanette Byrnes in Chapel Hill, N.C.
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