The running commentary on the U.S. economy can be reduced to two main themes. The first is that monetary and fiscal policies have run out of bullets. The second is that oil prices are responsible for our current malaise.
If that's the case -- if the
Federal Reserve is impotent, the federal government is broke and oil prices are responsible for the economy's ebbs and flows -- why not put OPEC in charge of economic policy?
Seriously, if you believe that soaring oil prices, which are cutting into household budgets and sapping consumer spending, are the main problem, why risk the unintended consequences of zero percent interest rates -- for an extended period -- when the Organization of Petroleum Exporting Countries could achieve the same kind of stimulus by opening the pump jacks?
You're probably thinking, she's kidding, right? Yes, I am. Influencing the demand for goods and services by manipulating the overnight interbank rate (the Fed's bailiwick) isn't the same thing as managing the supply, and the price, of oil. However, a reasonable person reading the analysis of why the U.S. economy is where it is today might be tempted to conclude the two are interchangeable.
Clearly President Barack Obama is sympathetic to the view that oil makes the world go round (and may impede his re- election). Last week, the president announced the release of 30 million barrels of oil from the nation's Strategic Petroleum Reserve, a storehouse designed for use in the event of true emergencies.
Time Lag
Why all the hoopla over oil? Simple. There are many more oil consumers than oil producers, which is why the cry goes out to “do something” when oil breaches $100 a barrel and gas prices hit $4 a gallon, which they did in May. No one ever mentions the benefits: the windfall profits that accrue to producers, shareholders and oil industry employees, all of whom are consumers in their own right. Most analysts ignore this aspect and treat higher oil prices as a dead-weight loss on the U.S. economy.
Even if the U.S. could satisfy all its energy needs domestically, the effect of oil prices on consumers and producers would still play itself out in distinct time periods.
Higher oil prices translate quickly to increased prices at the pump. But because oil exploration is a drawn-out affair -- a result of regulatory red tape and the nature of the process -- producers don't spend the additional revenue immediately, so it gets recycled into financial markets, which is reflected as an increase in U.S. savings, according to Jim Glassman, senior U.S. economist at JPMorgan Chase & Co.
Price Signals
How are producers reacting to higher oil prices today? Exactly as one would expect. The number of active oil rigs in the U.S. is up 42 percent in the past year to 1,003, the highest since 1987, which is when Baker Hughes Inc., the Houston-based oil services company, separated the rig counts for oil and natural gas. Investment in oil exploration rose an inflation- adjusted 32 percent in the first quarter of 2011 compared with a year earlier, according to the U.S. Bureau of Economic Analysis. And employment in oil and gas industries is up 7 percent in the past year compared with a 0.7 percent increase for total non- farm payrolls. It's amazing what price signals can do.
Last year, the U.S. consumed 19 million barrels of oil a day, according to the U.S. Energy Information Administration. Half of that was imported. Economists are very good at calculating what a $10 increase in the price of a barrel of crude oil means for consumer spending -- $10 times 19 million barrels a day equals $190 million a day or $5.78 billion a month -- and translating it to a dollar-for-dollar reduction in real gross domestic product growth.
Supply-Side Effects
What about the $36 billion in first-quarter profits earned by the five biggest U.S. oil companies? Where do they go? The only people considering that revenue stream are congressional Democrats in search of a whipping boy.
The profits don't disappear. Yes, higher oil prices represent a huge transfer of wealth from consumers to producers at a time when unemployment is high and many households are struggling. But higher prices also encourage new production, at least within the drilling constraints imposed by the Obama administration.
Even the dollars that go overseas in exchange for oil imports aren't buried under a sand dune. They're recycled into the U.S. Treasury market, for example, keeping interest rates low.
In short, everything that flows from the production side as a result of higher oil prices could be understood as “that which is unseen,” to borrow from the title of an 1850 essay by French political economist Frederic Bastiat.
Flying Blind
I suspect Bastiat, with his delightful, reductio-ad- absurdum analysis, would have approved of my notion of turning economic policy over to OPEC.
As it stands, we rely on the Fed to pick the interest rate that will keep the economy growing at its potential in perpetuity. That's like throwing darts at a board.
If oil prices are what drive the economy, surely picking the appropriate gas price is no more challenging than interest- rate targeting.
Just think of all the benefits. We could get rid of the Fed, make libertarian Representative Ron Paul happy and satisfy all the tree-huggers demanding a true U.S. energy policy.
(Caroline Baum, author of “Just What I Said,” is a Bloomberg View columnist. The opinions expressed are her own.)
