Stephen Roach on Oil Prices and the American Consumer

by: Stephen Roach

Excerpt from Morgan Stanley economist Stephen Roach's October 16th essay:

I have no idea where oil prices are headed, but I would offer a couple of observations before you crack out the champagne. First, soaring oil prices did absolutely no damage on the upside to either the American consumer or the global economy. Nominal oil prices essentially doubled from 2003 to 2005, while real consumption growth in the United States accelerated from 2.7% over the 2001-03 period to 3.7% over the 2004-05 interval; meanwhile, world economic growth averaged 4.9% over the past four years -- the strongest burst of global growth since the early 1970s. The ex post rationale for this seemingly paradoxical outcome is that it matters whether surging oil prices are an outgrowth of supply or demand. In the past couple of years, the price spikes are now viewed as an endogenous implication of robust demand -- so, of course, they didn’t hurt. Now, however, the hope is that falling oil prices will boost economic growth because the decline is coming from improved conditions on the supply side of the energy equation. In other words, the oil price has changed stripes -- what didn’t hurt will now help.

This pro-growth explanation could be wrong on two counts: First, I don’t think that the factors behind the recent oil price decline have been black and white; improved supply expectations may have helped but I suspect that reduced demand expectations were also at work -- a perfectly normal by-product of the slowdown bet. Nor do I think it is entirely accurate to calculate the windfall from last summer’s peak energy prices -- a spike that rational consumers tend to look through in their ongoing budgeting decisions.

Second, there is the saving response to the so-called energy-related tax cut. The oil price windfall is not the only thing going on here. The hissing sound you hear is that of the bursting of the US property bubble -- drawing into serious question the wisdom of asset-based saving strategies that have taken America by storm over the past decade. Absent the housing bubble, rational consumers focusing on life-cycle saving objectives -- especially those 77 million baby-boomers that will be starting to face retirement in the next few years -- should begin to shift back to income-based saving strategies. And with the income-based personal saving rate in negative territory for the first time since 1933, the urgency of that shift in a post-housing bubble climate cannot be minimized. That’s especially the case in light of the juxtaposition between saving and oil prices. In the three oil shocks of the past, the personal saving rate averaged 8% -- leaving consumers not only an ample cushion to withstand the blow of higher energy prices but also the wherewithal to step up and start spending when oil prices went the other way. At a zero or negative saving rate, no such cushion exists. This suggests that there is a much greater chance US consumers will save an energy-related tax cut rather than spend it. In short, I’m still a believer in the notion that -- lower oil prices or not -- the bursting of the housing bubble is likely to take a meaningful toll on the seemingly unflappable American consumer.

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