PRINT
EMAIL
COMMENT
BUZZ UP
DIGG
OUR PREMIUM CONTENT
The Kiplinger Agriculture Letter
The Kiplinger California Letter
Kiplinger's Biofuels Market Alert
Kiplinger's Retirement Report
SUBSCRIBER HELP
CURRENT LETTER
2009: A Rough Start
But a Better Finish
PREVIOUS ISSUES
Jim Griffin is economic consultant and portfolio adviser to ING Investment Management. He also is editor of ING Investment Weekly, the company's newsletter and is frequently quoted in The Wall Street Journal, Business Week, Bloomberg, Fortune, and other financial media. ING Investment Management is the global investment arm of the ING Group.Nobody likes to take a pay cut. The fact that most of us are taking one right now helps to explain why it's so ugly out there in financial markets these days.
The real purchasing power of incomes has been shriveled in the United States (and likewise across the world, although to a somewhat lesser extent in strong currency nations) by the doubling since last August of the price of crude oil. The result is a reduction in real incomes -- a pay cut -- for energy consumers around the world. And everyone is an energy consumer. The pain may be universal but it is hardly uniform: Some energy consumers are cushioned by otherwise high incomes, or comparatively low energy usage (can you walk to work?), or by the fact that they are, on net, energy producers, such as those whose livelihoods are derived from energy resources. This last group has been hugely benefited, on net, by the soaring relative price of oil.
Fool me twice, shame on me. We have, of course, seen this movie before. If you didn't live through the 1970s, perhaps you have a schoolbook familiarity with its history. A quadrupling of the relative price of crude oil in 1973-1974 led to a sharp inflation, as a result of misguided economic policies, in the prices of goods and services produced by energy consumers. That served to rebalance, at least partially, the terms of trade between energy buyers and sellers, but this feeble and self-mutilating riposte was slapped down by a subsequent tripling of oil prices in 1979.
The 1970s oil market crises were geopolitical in nature, rather than geological or economic, but you would have been playing with fire, perhaps literally, in trying to explain that to drivers as they drained their wallets while filling their tanks. Drivers are not much more patient today when the surge in energy prices is more clearly a demand-driven phenomenon that follows in train the rise of such populous giants as China and India. Competition can be exhilarating, but less so when you're not winning.
Having seen the original, we have a clue about how the sequel will proceed. But being powerless feels even worse than being clueless. There appears to be very little of a positive nature that can be done in the short run to cushion our pay cut. We have little leverage with oil producers as a group and perhaps even less with our fellow oil buyers. What do we do to compensate in the face of a pay cut? We might have augmented our incomes out of savings but for our savings deficiencies. Or we might have increased our borrowings if we -- and the banks -- weren't already tapped out.
And -- 1970s-era witticism here -- the Fed can't print oil. In standing pat on a 2.0% Fed funds target last week, the Federal Open Market Committee met market expectations and, in effect, acknowledged its limitations in offsetting the contractionary effects of high oil prices. Institutional memory is strong on Constitution Avenue and the humiliations of the Fed chairmanships of Arthur Burns and G. William Miller times are still fresh. Further, there is a distinction drawn there between the concepts of relative price shifts and inflation, the idea being that if the Fed doesn't accommodate it, the higher price of oil won't have a self-reinforcing corrosive effect on psychology and behavior.
I find that distinction to be somewhat murkier in real life than in abstract concept. A one-time shift upward in the price of oil is a one time real pay cut for oil consumers. If the monetary authority does not attempt to cushion the blow, the economy is likely to respond with a myriad of real adjustments and go on its way finally, poorer and wiser. Inflation happens when, as in the 1970s, the printing press is run in an attempt to replace lost real income.
The Bernanke Fed is unlikely to follow that course, as the upward tilt to Fed funds futures now indicates. But what is the word to describe a situation where a "one time" shift in relative prices is followed by a second time shift, and third time, and so on? West Texas Intermediate has moved from $70 per barrel to $140 over the past ten months in a nearly unbroken upward sweep. How many times is that?
The yield curve has flattened over the past three months as short rates have risen more on abandoned hopes for further Fed ease than long rates have backed up on inflation worries. Stocks have given ground on the implications for economic growth of the box that policymakers find themselves in. The dollar fades on the suspicion that, among oil consumers, the United States is in particularly poor posture. Oil addicted, geographically huge, regionally diverse and already the world's largest net debtor, it becomes difficult to see how we get out of this corner without a strong pull from exports that can be facilitated by yet more dollar weakness…which further constrains the scope for monetary accommodation.
Martin Wolf, chief economics commentator for the Financial Times, writes that the great global imbalance of the past decade or so is responsible for both the housing centered financial crisis and the inflation scares that are simultaneously underway. Emerging markets saved too much, protected their low cost currency advantages for too long, invested too much in U.S. capital markets. Americans borrowed too much, invested too much in housing ("unproductive" capital in the sense that it can't service international indebtedness). Chickens are now coming home to roost: inflation is surging in countries that refused to allow their currencies to rise relative to the dollar, and the dollar has become a constraint on the ability of the Fed to cushion the economic pain of the pay cut that the soaring oil price imposes.
Nobody likes a pay cut. It's ugly out there in financial markets. Real, if painful, adjustments are now under way. Those adjustments on our part will serve to lower costs and increase competitiveness. We've seen this movie before and it turned out quite well eventually, in a two-decade-long bull market following a fumbled response that made things worse than they needed to be. That lesson is likely to be heeded by the Fed, even if more politically responsive officials counsel differently. Markets will eventually come to see that enhanced competitiveness is a great boon in a world where the huge rising populations that are behind this "one time" oil price shift are also enormous market opportunities for virtually everything we produce.
This economic analysis originally appeared in ING's Investment Weekly. To read other articles by Griffin, click here.
POSTED BY: pete (July 23, 2008 12:30 PM)
Our collective "pay cut" is a direct result of Washington's weak dollar policy. I lived through the 70's and I see little difference -- print money then/ print money now. Where's the Fed's lesson learned?
POSTED BY: Brian Eichorn (July 23, 2008 09:14 PM)
This article reminds me a lot of the presidential debates...lots of sounds bites and absolutely no content.
POSTED BY: Anonymous (July 23, 2008 10:17 PM)
Poorly written-- should have stated UP FRONT what the Fed allegedly did wrong in the 70s, and I gave up reading this obtuse piece to figure out if you ever got around to even spelling out the Fed's 70s action(s).
E-Mail Article
Print Article
