Juan Carlos Martínez Lázaro. Professor at Instituto de Empresa
18 October 2004
What effect will skyrocketing prices of crude oil have on global monetary systems?
Since the beginning of the year, we have seen an increase in oil prices that has pushed the barrel above $50, matching figures reached in the early 1980s during the Iran-Iraq War, and the early ‘90s with Gulf War I. At that time, the significant rise of crude oil strongly affected the more developed economies, casting them into periods of recession.
Last spring, in the middle of an upward trend, all the analysts confirmed that the rise in the price of oil could end the incipient recovery of the world economy. Yet now the same voices insist that the two can coexist without great difficulty (a few tenths of a point less growth) at a crude oil price of around $40. The worst-case scenario forecasts, about the beginning of a new period of stagnation, have slowly faded away. Alan Greenspan, noting that the price was still three-fifths of 1981’s, said recently that the situation would be less consequential to inflation and economic growth than the oil shocks of the ‘70s. Technological progress, he predicted, would emerge and industry would shift away from oil.
Why is recovery of the world’s leading economies not slowing down, despite higher prices of crude oil? First of all, despite the fact that so far this year crude has shot up 35 percent, in real terms this is a much lower amount than the one recorded in previous crises. For the rise to have been equivalent to 1973 or 1979, the barrel would have had to reach around $100.
Furthermore, the developed economies are much less dependent on black gold than 30 years ago. This is partly due to diversification of energy sources, and partly due to greater efficiency in the consumption of energy. It is also a result of the need for reducing the gas emissions that cause the greenhouse effect, in accordance with the mandates of the Kyoto Protocol.
Finally, the increase in the price of crude is in part motivated by greater demand, owing to reactivation of the world economy and the increased consumption in Asia (particularly China and India). However, we must remember that most of the blame for the hike must be placed on relevant supply problems resulting from the explosive situation in Iraq, the general terrorist threat, instability of certain producers such as Nigeria, or the crisis of Russia’s Yukos oil company, which must come to an end sooner or later.
Until now, the sector hardest hit by higher oil prices has been transport, particularly air transport. The world’s airlines were already hurting as a result of the events of 11 Sept. 2001 and the appearance of low-cost rivals.
But today’s economic context is far different from that of other decades. As a result of tremendously expansive monetary and fiscal policies, the American economy is experiencing a vigorous period of growth. The increase in the cost of oil has had an unquestionable impact on prices generally. Yet it is no less certain that the cautious hikes in interest rates implemented by the Federal Reserve, when they were at a record low, respond more to a desire to adapt monetary policy to the economic recovery process than to fear of inflationist repercussions from more expensive crude.
On the other hand, Japan and the European Union have managed to partially control inflation which could have dismantled their slight recovery. This was achieved thanks to the strength of the yen and the euro in comparison with the dollar, which lowered the cost of crude oil imports.
What is true is that, so far, the oil-price increase has been more or less overcome. In the mid term, everything seems to indicate that pressure from demand and geopolitical risks will force the world’s economy to get used to a scenario in which crude is little likely to fall below $35. This, despite measures aimed at increasing production, such as recent decisions taken by OPEC.