Is It Possible the Current Recession Was Caused by Oil Prices, Not Housing? 35 comments
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What would you think if someone told you that all of the reasons advanced so far about the causes of this nasty recession were false and that there was another very simple explanation? If you’re like me you might want to not know about it. Throwing out all of the notions, ideas and conclusions running around your brain isn’t the most pleasant of prospects.
Well, James Hamilton is proposing that the whole mess is the result of the energy shock that rising oil prices delivered to the economy. In a paper that he presented to the Brookings Institution he goes back to 2003 and drawing on historical data of what an oil shock of the magnitude we experienced in 2008 would do to the economy. Here is the graph he produced to demonstrate the result:
click to enlarge
As you can see, the predicted path of the economy based on his hypothetical case is remarkably similar to the actual path. Hamilton professes to be shocked by the outcome of his research and even goes so far as to say that he has trouble believing in the results. Simple answers are often the hardest to accept.
He notes that the housing sector rather than being the prime cause of the crisis was only moderately impacting GDP at the time the oil shock occurred. That event then accelerated the decline in housing which ultimately overwhelmed the financial sector.
Here is how his paper concludes:
Eventually, the declines in income and house prices set mortgage delinquency rates beyond a threshold at which the overall solvency of the financial system itself came to be questioned, and the modest recession of 2007:Q4-2008:Q3 turned into a ferocious downturn in 2008:Q4. Whether we would have avoided those events had the economy not gone into recession, or instead would have merely postponed them, is a matter of conjecture. Regardless of how we answer that question, the evidence to me is persuasive that, had there been no oil shock, we would have described the U.S. economy in 2007:Q4-2008:Q3 as growing slowly, but not in a recession.
I’m still digesting all of this. If his argument is valid then there are implications for policy choices regarding recovery from the recession and certainly for energy policy. Some might argue that it is a great endorsement of the need to move to renewable energy sources, others that it suggests we have to drill like mad men in order to insure against further shocks.
What can’t be argued is that the economy can quickly adjust to a major increase in energy prices. Whatever path policy is to take, it has to pay particular attention to the imperative of maintaining energy price stability.
I almost hope he’s wrong. I really don’t feel like rethinking things.
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I think this 'cause' can be seen as a tertiary element as to what caused all this trouble - individual consumers over-leveraging their assets is primary, financials aiding and abetting the consumer is secondary, and then tertiary factors like a failed energy policy, failed health care initiatives for certain sectors (automotive), failed foreign policy, etc.
Realistically no one thing can really be attributed to the decline. So many aspects of the economy had turned unhealthy at once.
@Cetin "mostly profit taking"
Really?!? You believe a 56% drop is "profit taking"?
It is totally reasonable to believe that this run-up was related to the crash. Not the absolute cause, but inseparably linked.
I thought everyone was already there with me on that.
As I recall, there was a huge amount of speculation around oil prices which had as much to do with the concerns over the dollar given the two wars, the tax cuts and the looming housing crisis. It all seems so very different now, but the consumer was buoyed by confidence in ever rising property prices and seemingly inexhaustible cheap credit, so though there was plenty of carping about the high prices of fuel and thoughts of changing consumption habits, for most people nothing really changed. Of course, those prices are now included on our credit card balances as like everything else the costs were deferred.
I think the spike in oil was a precursor of the current situation, but not a cause of it, more like it was an early indication of the excess liquidity (and the illusion of wealth) and the pent up volatility in the markets which have wrought such havoc.
I suspect in 10 years time, we will look back on this period and seem that the oil market read the global economy correctly, but it rallied too early, came back down to earth with a crash, but will soon (which could be one year, could be three) head back up to previous levels.
I think that all major economic cycles are essentially real estate cycles.
www.foldvary.net/works...
But here is an interesting connection between oil prices and California real estate that probably applies to a few other regions as well.
The important coastal real estate regions, SF bay area, Santa Cruz & Monterey areas, LA & San Diego areas have always been quite expensive. Sacramento had also become expensive earlier. But in the 2004 (give or take) time period, the inland real estate regions, Stockton, Modesto, Salinas, & San Bernadino, inflated tremendously.
For many people, any auto commute less than 120 miles one-way from their new inland home to their place of work on the coast (or Sacramento), was acceptable.
When gasoline prices hit $5/gal. in California, the effect was crushing to those many long distance middle-class commuters. Throw in resetting interest-only or option ARMS and it became clear that the music had stopped.
The spike in oil prices occured as more dollars world wide chased the same amount of input goods that are used to feed and make everything. Oil is in our roofs, roads, plastics, fertilizers, gasoline, power plants, etc. Everything is transported using gas. Think about it. The whole time oil prices went up oil stocks were being slowly built up including a heck of a lot in the petrolium reserve. The real price shock was due to positive feedback loop speculation supported by a larger total money supply including M1 thru M3.
Once the extra money found its way into commodities the true value of the money and everything else was reset and is still being settled. Of course a certain amount of production capacity is being destroyed as their was mass over investment in goods and services that were only needed for the temporary artificial demand that was caused by the wealth effect.
Point is that we are experiencing the classic boom bust that the Austrian school of Economics predicted would happen with money supplies are used to artifically effect interest rates which when not manipulated provide natural breaking and accerlation mechanisms to provide balance to good investments and mal-investments.
Think of interest rates as the Darth Vador of the economy.
I will go one step further, could it have been manipulated by external agents who went after a single domino in an attempt to send a shudder through the financial and banking system?
Then you know very little about the average American household. The typical American has little-to-nothing in reserves. Most households could not withstand more than two missed paychecks.
The payment shock at the pump put a number of households over the tipping point. And, it scared the crap out of many others. Reduced consumer confidence triggered reduced driving as well as decreased consumption, which further exacerbated mortgage defaults.
excessive housing speculation bubble caused the financial instability but speculative oil certainly amplified/accelerated the damage.
> jack
I wish I had a way of doing the analysis, but I would imagine the shock from the increase in oil prices meant that the hours you work to cover fuel costs maybe went from 6 hours to 12, which though not pleasant, was more manageable than mortgage.
It seems to me that the policy of the Fed to aggressively cut rates, so the pain of the tech bubble was not as severe merely shifted it to a housing bubble. As property is a non-yielding asset, there is no offsetting income to put against the cost of the financing.
Remember the 1973 'energy crisis' when oil prices spiked? Pretty soon all the big Western banks were looking for ways to get their hands on all those Arab petrobillions to invest. Commodities were getting scarce and expensive so our bankers put all the Arabs' money in Third World commodities developments. A few years later all those new mines started producing a glut of commodities, prices collapsed, and many of our banks became technically insolvent when the loan-receiving countries started defaulting on their loans of recycled Arab petrobillions.
In the 1980s the big banks were allowed to write down the unpayable loans and resume business as usual, rather than being declared insolvent. This time it was US mortgages-cum-derivatives rather than Third World resources that all the petromoney was pumped into, but it was the same cause and the same effect. Oil price spikes put too much of the world's money into the hands of too few people. Those people can't spend all that money so they need to invest it, and bankers everywhere fall over each other trying to invent 'sound' investments that promise a good return on capital. In reality there are never enough profitable investment opportunities in the world at any given time to absorb that much fresh money, so the money always pumps up the currently trendy investment category which then proceeds to bubble and collapse. Meanwhile the general economy is starved because everyone spends all their discretionary income filling up their gastank to get to work.
Third World commodities; US mortgages. As long as the broker/banker gets his cut of the action up front, who cares what that flood of money is doing to the asset class or the economy.
In this instance, the basic influencing factors are Global & include:
1) Population (Aging & Total reduction)
2) Peak Oil
3) Climate Change
4) Greed
Unlike past economic slowdowns, including the Great Depression,this event has major structural blockages, which will constrict the Global economy, over the longer term and slowly crush the life out of the Global economy.
This event stated with one of the old players, Greed, which came to play with "sub-prime mortgages". However, those playing the game did not take into account what was about to happen in Housing, Commercial R/E & the general Global economy, resulting from Population (Aging & Total reduction) , Peak Oil & Climate Change.
The effects of Population Aging, in the form of Baby Boomer retirement & death, started showing up in Housing around 2005 and will continue to build through to 2040.
The ongoing Total Population demographics are then likely to trend down, as other factors intervene, with an ongoing dampening effect on the Global economy.
Oil supply also Peaked around the same time, as Hubbert suggested and with ramifications not only in gas pricing, but almost every other part of human existence, there MUST be an immediate & long term reduction in Global consumption or a replacement for Oil, within a very short period of time.
The longer term sleeper is Climate Change, but with the more dire consequences perhaps not impacting for 30-40 years +, there is still much debate and little action.
That said, this is possibly the greatest test ever for humanity, if we get it wrong, then we sentence future generations to a possible EE (Extinction Event).
Save something completely unknown, out of left field, we are in for a really long haul!