The U.S. Federal Reserve's bold action Tuesday to decrease short-term interest rates by 50 basis points, or one-half percentage point, served as clear signal to the markets that the Fed agrees that the housing slump and subsequent subprime mortgage default-induced credit crunch have helped slow U.S. economic growth to near-stall levels, but the interest rate cut and likely future cuts do not offer a downside-free economic horizon.
On the contrary, the easing and the growth stimulus that's likely to ensue will undoubtedly bring to the forefront an issue that the world's major industrialized economies have danced around for about a generation: namely, the inexorable rise in the price of oil.
Recall that in 2005 the Fed began to tighten monetary policy, i.e. started its short-term interest rate increase cycle, in part to slow the U.S. economy in order to take price pressure (inflation) off commodities, principally oil, but also natural gas, copper, aluminum, silver, corn and wheat, among others. Leaving aside for the moment the philosophical critique regarding whether its possible for a nation's central bank to slow inflation of globally-based commodities, the Fed's action did have the effect of slowing U.S. growth, which reduced price pressure on numerous vital commodities. Hence, from an inflation standpoint, the Fed's tightening can be interpreted as a qualified success.
But as U.S. economy and market watchers know, the U.S. economy slowed perhaps too much in 2007, and that fact, combined with subprime mortgage defaults in the second half of 2007, led to the economy's current near-stall conditions, which, as noted, led to the Fed's Tuesday decision to lower interest rates and begin a monetary policy easing cycle.
Moreover, the Fed's monetary policy decisions would look conventional were it not for the that fact there was one fly in the Fed's ointment: the price of oil, save for a six-month period from August 2006 to January 2007, has not declined substantially: oil's price, as tracked by the 200-day moving average, has moved incrementally higher, despite the Fed's actions.
That fact presents a stark reality for the developed, and now the developing markets of emerging economies (China, India, Brazil, Russia, Eastern Europe): the Fed, by lessening U.S. demand, could not stop oil's price rise. Global economic growth is the primary factor in the rising price of oil. And right now, there's little sign that international oil demand is likely to slow.
Further, the above fact, combined with the small gap between global oil production and consumption, all point to a scenario where oil marches higher. (Oil currently trades around $81.50 per barrel.)
How much higher? According to one theory, absent intervening factors, oil's price marches to the maximum level the market can bear without reducing demand. Other theories offer even more stark scenarios: these argue that given oil's vital commodity status -- currently oil is the essential energy source for much of the industrialized world -- oil's price continues to rise despite falling demand due to competition that breaks out among nations as shortages develop.
However, economists are quick to point out that intervening factors could slow oil's price rise: a substantial, sustained reduction in demand (stemming from private choices or public policy) and/or the emergence of a price-competitive, convenient, alternate energy source.
But absent those intervening factors, oil demand growth marches ahead, the price of oil marches ahead, and the global economy moves toward a moment of truth regarding oil: reduce demand or have a soaring price of oil reduce demand for you.
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Reader Comments (Page 1 of 1)
9-23-2007 @ 10:01PM
scooperson said...
Confession: I am an attorney.
I believe that all people need access to the courts and trial lawyers over the long term have done more good than harm. example: smoking industry, lung cancer! safer cars!
Falsely Blocking access to the courts is like censorship. Profit motives sometimes do conflict with human safety and there needs to be a forum to play the balance out.
I do have a problem however, with securities class actions. I rarely see any benefit to the shareholder and the class action attorney seems to be unjustly awarded. Maybe the answer is that before any attorney fees can be collected, the shareholder needs to be fully compensated, or the fees need to be adjusted relative to the shareholder compensation. This and also in other types of consumer litigation, I sometimes see attorney fee awards that are more than 10 times the actual damage award. Attorney fees should not be a form of "punitive damages." This is a delicate balance and hopefully, a reasonable solution will be reached. I know for one thing, that business and corporations cannot be allowed to go unchecked, but at the same time, honest business should not be subject to extortion in the form of a lawsuit..
sc
9-24-2007 @ 3:31AM
Dan Barnett said...
I know it's 3:30 in the morning & I am not thinking clearly, but did scooperson post to the wrong article? I thought this was about the price of oil.