If it looks like a duck, swims like a duck, and quacks like a duck, it’s probably a duck. And right now, this duck is looking a lot like an oil shock: In Brazil, a strike by truckers protesting the price of fuel brought the economy to a halt over the past week, interrupting exports of soybeans, coffee and chicken and prompting some to call for a return to military dictatorship; In India, prices for diesel and gasoline have hit multi-year records, leading to demands for the government to cut taxes and for a price cap to be imposed on state-controlled Oil & Natural Gas Corp. – a self-defeating expedient, as my colleague Andy Mukherjee explained this week; Governments in Thailand, Vietnam and Indonesia and implementing or planning increases in retail fuel subsidies to protect consumers from the effects of rising oil prices and weakening national currencies; Airline profits have probably peaked because of headwinds from fuel costs, according to Alexandre de Juniac, chief executive officer of the International Air Transport Association.
Philippine budget carrier Cebu Air Inc. this week promised to impose fresh fuel surcharges; Moody’s Investors Service just blamed high oil prices in part for a 0.2 percentage-point cut in its outlook for India’s 2018 GDP growth, and warned of the potential of falling consumption spending and rising inflation across the globe if current high prices are sustained. Judging by internet searches for the term, an oil shock is the last thing anyone should be worried about. It seems insane to be stressing over oil when Brent is struggling to break through $80 a barrel and West Texas Intermediate is bobbing around $70, about one-third lower than their levels four years ago. But crude has a short memory.
Take the first Gulf War. In the five months between Saddam Hussein’s 1990 invasion of Kuwait and the start of Operation Desert Storm, a spike drove West Texas Intermediate to an average $30.84 a barrel. Despite representing little more than a return to the status quo before Saudi Arabia flooded the market late in 1985, those prices were high enough to help spark the early 1990s recession. A 2011 analysis of previous oil shocks by James Hamilton of the University of California, San Diego, suggests they’re a strong predictor of downturns. Rapid oil price increases have preceded 10 of the 11 U.S. business cycle peaks since World War II; only in 1970, 1973 and 2003 – during or in the immediate aftermath of recessions – did a run-up in prices fail to herald the peak.
Over the past 11 months, Brent crude is up 62 percent and West Texas Intermediate has risen 46 percent – but does that constitute an oil shock? By one measure, it could. One way of analyzing such events, pioneered by Hamilton, is to compare current oil prices to their highest level over the previous three years. Where prices are below their previous peak, any increase can be considered a return to the norm; where they’re above that level, there’s the possibility of a genuine shock. On a Hamilton-style measure, we’re seeing the strongest flashing red light since 2008.
Are such fears premature? Real global growth will reach 4 percent this year for the first time since 2011, the Organisation for Economic Co-operation and Development forecast this week. Consumer prices, which have been slumbering for a decade in developed countries, could arguably do with an extra kick from higher energy prices to fuel core inflation and speed the return of central bank rates to pre-crisis levels. The Conference Board’s U.S. Leading Index, one widely watched measure of turns in the business cycle, is at some of its highest levels on record.
At the same time, we shouldn’t expect to see many other signs of weakness yet because oil shocks are prophets, not partners, of slowing growth. And while higher prices don’t yet appear to be seriously crimping consumer spending in rich countries, trucker strikes and government subsidies elsewhere are a strong signal that the cost of crude and slumping currencies are eating into incomes elsewhere. That should provide an extra impetus to governments in Saudi Arabia and Russia in deciding how much to increase exports. With U.S. crude locked up onshore by infrastructure bottlenecks, a surge in supply and easing in prices may be the only thing standing between us and the next downturn.