Is the world economy suffering from 'high-priced fuel syndrome'?

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.

Our Finite World

Gail Tverberg, an actuary with a background in math, analyzes energy and financial matters from a perspective that the world has limited resources. For more of Gail's posts, click here.

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  Graphic: Figure 1. Historical inflation adjusted oil price per barrel, (Brent equivalent in 2011$), based on amounts shown in BP’s 2012 Statistical Review of World Energy.
  (BP)

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  Graphic: Figure 2. Author’s illustration of impacts of declining resource quality.
  (Gail Tverberg)

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  Graphic: Figure 3. Comparison of Food and Oil Prices. Food Prices indices are as published by the Food and Agriculture Organization (FAO) of the United Nations, available at http://www.fao.org/worldfoodsituation/wfs-home/foodpricesindex/en/ Oil prices are monthly average Brent Oil spot prices, as published by the US Energy Information Administration. http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=rbrte&f=m
  (US Energy Information Administration)

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  Graphic: Figure 4. US Government Income and Outlay, based on historical tables from the White House Office of Management and Budget (Table 1.1). *2012 is estimated. http://www.whitehouse.gov/omb/budget/Historicals
  (White House Office of Management and Budget)

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  Graphic: Figure 5. Historical average annual oil prices, (“Brent” or equivalent) in 2011$, from BP’s 2012 Statistical Review of World Energy.
  (BP)

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  Graphic: Figure 6. S&P/ Case-Shiller 20 City Home Price Data, using seasonally adjusted data. June 2006 is the peak month. Data from http://www.standardandpoors.com/indices/sp-case-shiller-home-price-indices/en/us/?indexId=spusa-cashpidff–p-us—-
  (S&P)

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  Graphic: Figure 7. Intended Federal Funds Interest Rates, as set by the Federal Reserve Open Market Committee http://www.federalreserve.gov/monetarypolicy/openmarket.htm
  (US Federal Reserve)

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  Graphic: Figure 8. Oil Consumption for Selected Areas, based on BP’s 2012 Statistical Review of World Energy
  (BP)

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  Graphic: Figure 9. Repaying loans is easy in a growing economy, but much more difficult in a shrinking economy.

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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:

1. 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.
2. If citizens are working fewer hours or laid off, the amount of taxes they pay is lower.
3. Banks and other industries are likely to need bailing out, as borrowers default on loans.
4. The government will be faced with direct increases in costs, because the government uses oil to fuel its autos and jets.
5. The government will face increasing costs on products it buys that use oil, such as asphalt for highway projects.
6. 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.

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