There has been much “its different this time” talk as the oil price has soared over the last few weeks. Even at $95 it hasn’t hit anything like the highs it saw in the 1970s – it would need to hit somewhere around $110 for that say most analysts.
We also spend a much smaller part of our incomes on oil related products than in the 1970s so even at $110 things won’t be as bad as they were then.
The consensus? There is no way that a high oil price can, on its own, cause a recession.
But the point the optimists miss is that oil doesn’t have to do it on its own. This year it has hordes of willing helpers. For starters it is not the only thing rising in price rather too fast for comfort. We’ve heard a lot about food prices in the last few months but perhaps more frightening for those tasked with keeping inflation low is the little reported rise in wages in Asia, something that will feed through into the prices of manufactured goods around the world: a recent survey showed average salaries in India and China up 14% and 8% respectively this year. The lack of inflation in developed economies over the last decade has had more to do with the low prices of good coming out of developing countries than any thing else. If this side effect of globalization is coming to an end – as rising salaries suggest it is – central banks should be worried: with prices rising it’s hard for them to cut interest rates as fast as they might like in times of crisis.
This is a shame as oil’s next little helper, the credit crunch, is clearly something of a crisis. Consider the sheer scale of the losses. Merrill Lynch just admitted to another $8bn in losses; UBS has confessed to $3.4bn and analysts say there are many more billions to come; while there’s a similar scale of disaster at Citibank. This all adds up to real money – and it isn’t over yet.
The losses all stem in various complicated ways from mortgage defaults in the US but house prices there are still falling and default rates are still rising – ever more sharply. The bulls say all these losses (which some say will hit a total of well over $100bn) don’t matter to the rest of us, that the problems remain contained inside the financial sector. This rings less and less true as the weeks go by: the world’s big banks control the amount of credit borrowers (corporate and retail) can get their hands on so when they are in trouble – cutting the risks they take and the loans they make – we are all affected.
The real economy is also heavily influenced by falling house prices: the more they fall the less consumers can spend so the fact that they won’t stop falling in the US is hardly helpful either. Note that even supermodel Gisele is so depressed at the state of the US economy in particular that, according to an interview with a Brazilian magazine she now always asks to be paid in euros instead of dollars.
So what should investors do? I think I’d stick with my suggestion of 4 weeks ago and hang on to some gold. The price has jumped 9% from $734 to around $800 since I first mentioned here but given the whiff of stagflation about I think it is worth sticking with.
First published in The Evening Standard