Tax Cuts, Lower Oil Prices Will Boost Economy

The financial crisis, economic turmoil, and the stock market sell-off have investors in the doldrums. One bright spot, however, is the recent plunge in oil prices. While this is a welcome development, it is not entirely unexpected. In recent years, easy monetary policy brought us the tech stock bubble, the housing bubble, and the commodities bubble.

High oil prices were largely the result of a weak dollar. They had less to do with strong demand or too little supply. Perhaps it took longer than it should have, but high oil prices finally caused the demand destruction we have been expecting. In reality, this destruction has been going on for months, but it become noticeable only recently. For example, the Department of Transportation just documented a decline of 15 billion fewer miles driven in August 2008 than in August 2007. But it's already late October. No doubt, demand has continued to fall during the last two months as well. Furthermore, as I explained more than a month ago in Forbes magazine, "with global economies slowing, the dollar strengthening and U.S. demand declining, even the threat of hurricanes can't keep oil's price up."

OPEC has long been saying there is plenty of supply. Now it is worried there is too much. Cooler heads at OPEC never wanted to see prices go as high as they did because they feared high prices would cause a global recession—something that is clearly bad for their business. Now they are just as worried that prices will plunge to levels not seen in years. This is why OPEC just announced a 1.5 million barrel per day production cut.

But just as OPEC was unable to keep prices from spiking, it is likely to find that it can't prevent prices from falling. Some OPEC nations with weak economies were already exceeding their quotas, trying to sell as much oil as they could at ridiculously high prices. On paper, these nations are entirely in favor of a production cut. However, in practice, they will find it much harder to stick to their promises.

Some economists fear that lower oil prices will cause Americans to return to their profligate ways—putting conservation aside and buying up SUVs and pick-up trucks once again. This won't happen. Every automobile company has invested millions—if not billions—retooling their factories to produce more fuel-efficient vehicles. No one is in favor of going back to old ways.

Lower oil prices and more efficient cars will leave consumers with more cash to spend on other things. This could do as much good as a meaningful tax cut, helping to revive the economy. Combine lower oil prices with a real tax cut and the economy is likely to boom. But if OPEC manages to push oil prices back up to recent highs, the U.S. and the entire world will have an extremely difficult time shaking off this recession.

Comments

[john s. gordon:]

tax cut is not in the cards. the federal budget deficit and accumulated national debt (thank you emperor george W) are simply too huge.
> jack

2008 Oct 26 09:31 AM

[Badcowboydan:]

You are assuming the consumer is still as willing to spend as he was (which he is not), and everyone gets to keep their jobs (which they won't). There is a little more to this than the price of oil.

2008 Oct 26 09:47 AM

[NOWHEREMAN:]

Vahan, Great call on AGCO.

In about 3 months you have managed to lose investors who followed your advice more than 50%. On that basis, I think I will start to seriously look at the oil sector again... to buy shares of companies in it.

2008 Oct 26 10:44 AM

[scfranklin94:]

John Gordon is right; there will be no tax cut; there might be more attempts at stimulus packages that do nothing for the economy except increase our national debt.

2008 Oct 26 01:41 PM

[User 167260:]

He must be related to Kudlow, How do they figure it will help the broken consumer is beyond me. Gas is still paid with money from a job that people don't have or are losing, most all working people's wealth depleted or will be soon, housing implosion, utilities raised, food raised, taxes raised on depreciating homes, The only thing it will do is take some pressure of the companies, but it's not enough to create jobs. The most it will do for the consumer is let them buy necessities, they get to move up to Mac & cheese from ramen noodles.So get off the dumbness, Good God people.

2008 Oct 26 05:03 PM

[mangolfer:]

What a bunch of negative comments. Yea it will probably get worse before it gets better, but personally as a sales rep, my little company is saving over $1000 per month with cheaper gas. This is much better then any stimulus package. Housing is turning around in some areas already. People trying to time the bottom may get burned. And yes we will survive.

2008 Oct 27 07:52 AM

[inthemoney:]

> User 167260 He must be related to Kudlow, How do they figure it will help the broken consumer is beyond me. Gas is still paid with money from a job that people don't have or are losing, most all working people's wealth depleted or will be soon, housing implosion, utilities raised, food raised, taxes raised on depreciating homes,
----------------------...

LOL. I agree completely.

2008 Oct 27 02:44 PM

[website:]

Thats a good Question!

Jan 01 06:01 PM