The View From 1776

Oil Price Main Recession Culprit?

Onset of the worldwide recession correlates with the timing of oil price increases, but that’s only part of the story.

My thanks to David Airth, a frequent poster of comments on this website, for bringing to my attention an interesting analysis that was reported in the Toronto Globe and Mail.

That article describes the contention of economist Alan Reynolds, a senior fellow at the Washington-based Cato Institute, that neither the housing bubble, nor Wall Street greed was the main effectuator of the economic downturn besetting the world.  He notes, instead, that our current recession and others since the end of World War II have been triggered by price increases in oil, which simultaneously affect the entire economy.

While not disagreeing with Mr Reynolds about the negative impact of oil price increases, I would step back a few paces to examine what induced the postwar increases in oil prices.  In every case, oil price increases were preceded, and by implication, caused in major part, by surges in the dollar money supply. 

OPEC was formally organized in 1960 after President Eisenhower imposed import quotas on oil from Venezuela and the Persian Gulf.  The punishing oil shortage imposed by OPEC in 1973 was both a political move to undercut American foreign policy support for Israel, and a reaction to the inflation-caused declining purchasing power of the dollar, the currency in which most overseas producers were paid.

Measured in 2008 dollars (i.e., adjusting for inflation), the price of oil was very stable, around $15 to $20 per barrel, from 1931 until 1971, when the inflationary effect of President Johnson’s Great Society socialist welfare-state entitlements programs began to manifest itself.  The same pattern was exhibited in the oil price spike beginning in 2005, as the Fed continued to keep the money-supply spigot wide open.

In addition to inflation-induced declines in the value of the dollar, of course, oil prices were pushed upward by surging consumption in China and by the uncertain availability of Persian Gulf oil supplies because of the Iraq War and rising tensions with Iran.

Nonetheless, the dollar’s loss of purchasing power because of the Fed’s actions was a major trigger in the run-up of oil prices.  Measured in ounces (actually small fractions of an ounce) of gold, the price per barrel of oil was almost exactly the same in 2007 as in 2000.  During that same period, however, the price of oil in dollars leaped 250% to 3.5 times the price in 2000 (Wall Street Journal; Oil and the Dollar, January 4, 2008;