IF you have been following the news about oil prices you are probably totally confused or seriously misinformed. The situation is both much better and far worse than you have been led to believe.
Let’s start with the “better”. When prices hit $40 a barrel, motorists were upset — or so we are told. But Americans keep buying gas-guzzling sports utility vehicles, and filling their tanks with petrol that costs more than $2 a gallon (30p a litre). So talk of high prices causing consumers to sulk on their couches rather than drive long distances to visit granny this summer, or take a spin down to the shopping mall, seem overblown, especially as the economy gathers steam, jobs become more plentiful and incomes rise.
There is good reason for this lack of reaction. Petrol prices may seem high compared with a few months ago, but for a true picture we need to look back several years, and compare like with like. The Federal Reserve Bank of Dallas estimates that if we adjust for inflation, crude prices would have to rise to $75-$80 a barrel. and petrol to $3.50 a gallon, to be where we were in 1981. So oil and petrol prices are not devastatingly high by historical standards.
Two other facts have to be entered on the “better” side of the ledger. The first is that the drain of high oil prices on the American economy is not as great as press reports suggest. Almost half of America’s oil comes from domestic fields, meaning that a significant part of the higher price is paid by American motorists to American oil companies and their American shareholders and employees. And part of the rest is recycled to America when the Saudis drop by to denude Fifth Avenue, Madison Avenue and Rodeo Drive of their luxury goods, Arab students pay tuition fees in American universities, and Arab dictators and royals purchase Boeing 747s for their personal use and fighter planes to keep their militaries happy and loyal.
The final bit of good news relates to the impact of higher oil prices. Various government and private forecasters say that $40 oil will cut about 0.5% off American and world GDP growth. This brings to mind the old joke: “Economists use decimal places to prove they have a sense of humour.” GDP estimates are enormously crude, and often subject to major revision. Forecasts of GDP are even chancier. For forecasters to believe that they can translate a given increase in oil prices into a 0.5 percentage-point change in GDP growth is hubris of a sort not seen since Nikita Khrushchev predicted in the early 1960s that the growing Soviet economy would bury America’s in a few short years.
Besides, even if these analysts have crystal balls of unusual quality, the American economy might grow this year at a rate of, say, 4.5% rather than 5%, hardly something that would cause sleepless nights to the team working on the president’s re-election campaign. And, as Larry Lindsey, former head of the White House economics team, reminded me, the 0.5% “hit” from higher oil prices would be a one-off affair, after which growth would resume, although from a slightly lower base.
Unfortunately, there is more to the oil story than the good news. The bad news is that this is probably not a price “spike” — a temporary surge, with a specific and transient cause as we saw last year when war in Iraq was looming. Demand for oil is surging, with China providing more than half of the new demand, and America about 20%. Meanwhile, supplies are tight, in good part because Saudi Arabia persuaded the Opec cartel to cut output. The Saudis have excess capacity and have talked about opening the valves, but have not actually done so.
Never mind that American and British troops stood between Saddam and the palaces of thousands of Saudi princes when the Iraqi army rolled through Kuwait in 1990: gratitude is not one of the features of Saudi foreign policy. The Saudis will expand output and lower prices only if they become convinced that higher prices will make alternative technologies or new supply areas competitive, or induce a demand-shrinking recession in the West. So high prices may be with us for a while — a plateau rather than a spike.
That, however, may be the least of our problems. The greater problem, and a potential catastrophe for the world economy, would be an American defeat and withdrawal from Iraq. This would send a signal to Osama Bin Laden and his crew that they are free to pursue their goals without fear of an America that is sulking in its tent, as it did after Vietnam.
This brings us back to Saudi Arabia. The recent killings in the kingdom’s Yanbu oil hub show that the royal family’s tight control is slipping. With millions of young Saudi men unemployed, disenfranchised and trained in their mosques to hate America, there is mounting danger that the royals will be overthrown, regardless of whether they introduce modest reforms or crack down on dissent. Worse still, a new regime may prefer caves to palaces, as Bin Laden clearly does.
If the nation’s new, radical leaders believe they can bring down western economies, even at the cost of their own prosperity, they would willingly cut back oil production to drive prices to levels that would, indeed, induce a worldwide recession. The West would then have to borrow Spain’s white flag, or beg a weakened America to return to the fray after licking the wounds incurred in Iraq.
That’s what is at stake in Iraq. If America retreats, the enemies of the West will believe that nothing stands between them and their ultimate goal of world domination and an end to modernity. All they need is control of what they call “the oil weapon”, which can be used as a weapon of mass economic destruction.
Next time you cannot persuade a critic of George Bush or Tony Blair of the moral correctness of their Iraq policy, try this economic argument. It might just work.
Irwin Stelzer is a business adviser and director of economic policy studies at the Hudson Institute
