Is the world economy suffering from 'high-priced fuel syndrome'?
The major issue for many countries is that oil is becoming too expensive for the economy to afford, Tverberg writes.
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Businesses again have the choice of raising the price to consumers, or facing declining profits. If they raise prices, they will be less competitive with suppliers from other countries, who may not be facing rising electricity costs, if their source of electricity (perhaps coal or nuclear) is not rising in price as fast.Skip to next paragraph
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If electricity prices rise, consumers’ budgets will be stressed in a similar way to the way that they are stressed by rising oil prices. This, too, can be expected to lead to a cutback in discretionary expenditures.
Follow-on effects. Laid-off workers may move in with relatives and cut back on driving to save on costs. This helps reduce demand for both homes and automobiles. With less demand for homes, housing prices may decline, especially in parts of the country with significant layoffs and plentiful housing supply.
Laid-off workers may default on loans, creating financial distress for banks. Even people who still have jobs may find the hours they work reduced, so that their take-home pay is lower. They too may cut back on discretionary expenditures.
Impact on Governments
Governments suffering from high-priced energy syndrome can expect a number of negative impacts:
- Laid-off workers expect to collect unemployment benefits. If there are other kinds of benefits that they might collect under some other program (disability, retirement, low-income assistance), they will want them as well.
- If citizens are working fewer hours or laid off, the amount of taxes they pay is lower.
- Banks and other industries are likely to need bailing out, as borrowers default on loans.
- The government will be faced with direct increases in costs, because the government uses oil to fuel its autos and jets.
- The government will face increasing costs on products it buys that use oil, such as asphalt for highway projects.
- Local governments may face reduced tax revenue because of declining home and business property values.
Figure 4 below shows US Federal Government Income and Outlays, in recent years:
It is clear from Figure 4 that income had dropped at the same time outlay has risen. Even though the crisis is supposedly past, there is still a huge gap between income and outlays. Outlays in recent years are higher than would be expected based on pre 2005 trends, while revenues are lower than would be expected. Revenue would need to be more than 50% higher, to match outgo, for 2009 through 2012 fiscal years.
The amounts shown in Figure 4 are consolidated, so include programs such as Social Security and Medicare, besides “on budget” spending. How many readers could afford to contribute 50% more than they currently pay for the sum of (Federal Income Taxes + Social Security + Medicare funding)? If the government were to actually raise taxes this much, there would be a huge new round of lay-offs, because consumers would find their after-tax income much reduced, leading to even more cuts in discretionary spending.
Needless to say, the US government will do everything in its power to cover up its problems. In a later section, we will discuss how this huge deficit is being hidden.
Note that the only years during which US Federal Government income exceeded outgo in Figure 4 are 1998 through 2001. These years approximately coincide with the time period when historical oil prices were at the lowest level in recent years (Figure 5, below).
Impacts of the Oil Price Increase in 2006 – 2008 Period
While most people now don’t think of oil prices in 2006 as being high, according to Figure 5, oil prices already had more than doubled from 2002 levels by 2006. If we look back at the financial situation in 2006-2007, we see impacts very similar to what we would expect from rising oil prices.
Sub-prime borrowers began to default as early as 2006 (Bernanke, 2007). As mentioned earlier, it was people who were on the “edge” financially who were most at risk of defaults on home loans. Sub-prime borrowers would seem to be on the “edge” financially and thus were particularly as risk, because they lacked the financial qualifications to obtain “prime” interest rates.